How long your cash is trapped in the business

The cash conversion cycle measures, in days, how long money is tied up between leaving your account and coming back.

CCC = DSO + DIO - DPO DSO = receivables / revenue x 365 (days to get paid) DIO = inventory / cost of sales x 365 (days holding stock) DPO = payables / cost of sales x 365 (days before you pay)

Read it as a sentence: you buy something, hold it for DIO days, sell it, wait DSO days to be paid, and in the meantime you held onto your supplier's money for DPO days. The net is what you funded yourself.

A positive number is working capital you have to finance, out of your own cash, an overdraft or an invoice facility. A negative number means your customers pay you before your suppliers need paying, and growth generates cash rather than consuming it. Supermarkets and most subscription businesses run negative cycles, which is why they can grow quickly without raising money.

The number that matters is not the level but the direction. A cycle stretching from 40 days to 60 days while revenue grows is the classic profitable-but-insolvent pattern.

An agency with £600,000 of annual revenue, £300,000 of cost of sales, £90,000 owed by clients and £25,000 owed to subcontractors. No inventory.

• DSO = £90,000 / £600,000 x 365 = 55 days
• DIO = 0 days, there is no stock
• DPO = £25,000 / £300,000 x 365 = 30 days
• CCC = 55 + 0 - 30 = 25 days

Twenty five days of cost of sales is roughly £20,500 permanently tied up. Double the revenue with the same terms and that becomes £41,000. The growth itself consumed £20,500 of cash that never appeared as an expense in the profit and loss account, which is exactly why the business can look profitable and still be short.

Getting DSO from 55 days to 35 days releases about £16,400 in this example. That is usually easier and always cheaper than borrowing it.

In rough order of how much they help relative to the effort:

• Invoice on completion, not monthly. A job finished on the 2nd that is invoiced on the 30th has already lost 28 days before the clock starts.
• Shorten the stated terms. Most small suppliers default to 30 days without ever having chosen it. 14 days is normal in many sectors.
• Take a deposit. A 30% deposit on a 60-day project can move the cycle negative on its own.
• Chase before the due date. A reminder three days before is a courtesy; the same message a week late is a collections call.
• Use your own supplier terms. Paying everything the day the bill arrives is a habit, not an obligation.

Days sales outstanding is usually the largest and the most controllable of the three, which is why it is the first place to look.

• Averages hide seasonality. A business with a Q4 peak has a cycle that swings wildly through the year. A single annual figure can look comfortable while a specific month is not.
• One late payer distorts everything. The ratio uses total receivables, so a single overdue invoice from a large client can move DSO by weeks and suggest a systemic problem that does not exist.
• Deferred revenue is not in this formula. A business paid annually up front has a genuinely negative cycle that the standard calculation understates.
• Invoice finance flatters it. Factoring converts receivables to cash quickly, which improves the measured cycle without improving the underlying terms. You have bought the days rather than fixed them.
• It says nothing about profitability. A business can have an excellent cash cycle and still be losing money on every sale.