Working Capital 101: Know your cash-conversion cycle

A company’s cash-conversion cycle is the amount of time it has merchandise in inventory plus the time it takes customers to pay them minus the time it takes to pay vendors.

  • Days sales in inventory (DSI) is calculated as inventory divided by one day of merchandise cost of goods sold (usually COGS excluding depreciation). This is basically how long merchandise sits on the shelf, in the warehouse and in transit.
  • Days sales outstanding (DSO) is calculated as accounts receivable divided by one day of sales. This is how long it takes customers to pay and is usually only a few days for credit card processing in a consumer-facing businesses.?For companies providing credit directly to their customers, however, it can be much longer.
  • Days payables outstanding (DPO) are calculated as accounts payable divided by one day of cash operating expenses. This is basically the average payment term to vendors and can include payroll expenses, which are usually under 14 days. For the retailer, this is what they owe to vendors and employees – and rent expense if the lease liability is included in accounts payable.

DSI + DSO – DPO = cash-conversion cycle, or the amount of cash the business needs for working capital.

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