How effective is your company at managing its working capital? The cash conversion cycle can tell you. It measures the length of time, in days, that it takes your company to convert the cash you invest in inventory back to cash again. Once you purchase inventory stock, the timer starts running. It stops when you’ve sold the inventory and paid your bills. The cash conversion cycle is also known as the ‘cash-to-cash cycle’ or simply the ‘cash cycle.’
Cash Conversion Cycle Formula
Here’s the formula for determining your cash conversion cycle:
Days Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding = Cash Conversion Cycle
Days Inventory Outstanding
This is the average number of days your company holds inventory before selling it. To calculate Days Inventory Outstanding, divide your average inventory by the cost of goods sold per day and multiply the result by 365.
Days Sales Outstanding
This is the the time it takes to collect payment after selling your products. To calculate Days Sales Outstanding divide your average accounts receivable by total credit sales, and multiply the result by 365.
Days Payables Outstanding
This metric represents the the length of time it takes you to pay your invoices for the inventory you purchased. To calculate Days Payable Outstanding, divide your average accounts payable by the cost of goods sold, and multiply the result by 365.
Evaluating Your Cash Conversion Cycle
The shorter your cash conversion cycle, the more effective you are at managing your capital and the more likely your company has a positive cash flow.
Financial reports help you see how much you’re making and where your business stands. Improve your cash flow with invoices, payments, and expense tracking. See how much cash you have on hand with QuickBooks.