The cash conversion cycle: A key metric for improving your company's financial health

Cash flow is the lifeblood of your business. Without it, even the most profitable companies can stumble. That's why smart finance leaders pay close attention to the cash conversion cycle (CCC)—a powerful metric that reveals how quickly your company turns inventory investments into actual cash.

The CCC measures the time between paying for inventory and collecting payment from customers. A shorter cycle means cash returns to your business faster, improving liquidity and reducing financing needs.

For CFOs and finance executives, optimizing your cash conversion cycle delivers tangible benefits: freed-up capital for operations, reduced borrowing costs, and greater flexibility to act on growth opportunities. A well-managed CCC strengthens your balance sheet and provides a competitive advantage in your market.

Understanding the cash conversion cycle formula

The cash conversion cycle combines three operational metrics into a single formula:

CCC = DIO + DSO - DPO

Here's what each component represents:

• Days Inventory Outstanding (DIO) measures how long inventory sits before being sold.
  Calculate it using: (Average Inventory ÷ Cost of Goods Sold) × 365. Lower values indicate faster inventory turnover and better efficiency.

• Days Sales Outstanding (DSO) tracks how long it takes to collect payment after a sale.
  The formula is: (Average Accounts Receivable ÷ Revenue) × 365. Lower DSO values show you're collecting payments more efficiently.
• Days Payable Outstanding (DPO) measures how long your company takes to pay suppliers.
  Calculate it with: (Average Accounts Payable ÷ Cost of Goods Sold) × 365. Unlike the other metrics, a higher DPO (within reason) benefits your cash position by allowing you to retain funds longer.

Example Calculation

Let's see how this works with a real-world example. Consider a manufacturing company with $500,000 in average inventory, $800,000 in average accounts receivable, and $400,000 in average accounts payable. Their annual revenue is $5,000,000, and their cost of goods sold is $3,000,000.

Working through the calculations: DIO equals 61 days (($500,000 ÷ $3,000,000) × 365), DSO equals 58 days (($800,000 ÷ $5,000,000) × 365), and DPO equals 49 days (($400,000 ÷ $3,000,000) × 365).

Therefore, their cash conversion cycle is 70 days (61 + 58 - 49), representing how long cash remains tied up in operations from initial inventory purchase to final collection.

The cash conversion cycle's impact on working capital

The relationship between the cash conversion cycle and working capital management is direct and powerful. Working capital—the difference between current assets and current liabilities—represents the funds available for your company's day-to-day operations. Your CCC directly influences how much capital remains tied up in these operations versus available for other purposes.

A shorter cash conversion cycle improves working capital by:

• Freeing up cash that would otherwise be locked in inventory or receivables.
• Reducing dependence on short-term borrowing.
• Decreasing interest expenses associated with financing working capital needs.
• Enabling more strategic deployment of financial resources.

This improvement in working capital affects your company's liquidity and financial flexibility. With more available cash, you can better navigate seasonal fluctuations, unexpected challenges, and strategic opportunities. This flexibility allows you to make decisions based on long-term business objectives rather than short-term cash constraints.

The benefits of reducing your cash conversion cycle extend beyond immediate financial improvements. An optimized CCC can lead to:

• Enhanced ability to fund growth initiatives internally.
• Improved return on invested capital.
• Stronger credit ratings and access to more favorable financing terms.
• Greater resilience during economic downturns.
• Competitive advantage through financial efficiency.

For finance leaders, focusing on CCC optimization represents a practical approach to improving overall financial performance without necessarily requiring increased sales or margins.

Read the blog → How does an increase in accounts receivable affect cash flow?

Strategies to improve your days sales outstanding (DSO)

Reducing days sales outstanding represents one of the most impactful ways to improve your cash conversion cycle. By accelerating payment collection, you can significantly enhance cash flow and working capital availability. Here are key ways to lower your DSO:

• Automate your invoicing process: Send invoices electronically to eliminate mail delays and ensure immediate delivery. Electronic invoicing reduces errors and provides clear tracking of when customers receive invoices.
• Offer multiple payment options: Make it easy for customers to pay by accepting various payment methods, including ACH, credit cards, and online payment portals. The more convenient it is to pay, the faster you'll receive funds.
• Implement clear payment terms: Set explicit expectations at the beginning of customer relationships. Clearly define due dates, late payment penalties, and any available early payment discounts.
• Segment your customer base: Categorize customers by payment history and create tailored collection strategies for each segment. High-risk customers may need more frequent contact and stricter credit terms.
• Tighten credit standards: Consider running credit checks on new customers and requiring deposits for larger orders.
• Use intelligent collections workflows: Create structured, automated collection sequences that escalate appropriately. Start with gentle reminders and progress to more direct communications for seriously overdue accounts.
• Leverage predictive analytics: Apply AI-driven insights to identify which accounts are likely to pay late. This allows your team to proactively address potential issues before they affect your DSO.
• Streamline dispute resolution: Create a clear process for identifying and resolving customer disputes quickly. Unresolved disputes are a common cause of extended DSO.
• Monitor customer payment patterns: Track how and when customers typically pay to identify changes in behavior that might signal financial distress or process breakdowns.

These strategies work best when implemented as part of a comprehensive approach to receivables management. Billtrust's Cash Application solution supports many of these strategies by automating payment matching through machine learning, reducing manual intervention, and providing visibility into payment trends that affect your DSO.

Optimizing days payable outstanding (DPO)

Extending your days payable outstanding offers another avenue for improving your cash cycle while maintaining strong supplier relationships. Financial statements often reveal opportunities to optimize this metric through thoughtful adjustments to payment timing and terms.

Effective DPO management strategies include:

• Standardize payment terms: Establish consistent payment windows across your supplier base to simplify processing and create predictable cash outflows.
• Negotiate volume-based terms: Work with key suppliers to secure longer payment periods in exchange for purchase volume commitments.
• Implement electronic payments: Replace paper checks with digital payment methods that allow precise timing of when funds leave your accounts.
• Review payment schedules: Adjust payment timing to align with your company's cash flow patterns and revenue cycles.
• Consider supply chain financing: Explore programs that allow suppliers to receive early payment while extending your DPO through third-party financing.

Balancing DPO extension with vendor relationships requires thoughtful consideration of your suppliers' needs. Consistently stretching payments beyond agreed terms risks damaging these relationships and potentially disrupting your supply chain. Corporate finance leaders recognize that maintaining supplier goodwill ultimately supports long-term business success.

Centralizing and automating accounts payable processes enhances operational efficiency through greater visibility into upcoming payment obligations and more precise timing of disbursements. Modern cash management practices include strategic payment scheduling that maximizes your DPO while honoring supplier agreements. This approach reduces processing costs while improving data quality for supplier negotiations and financial planning.

Reducing days inventory outstanding (DIO)

Optimizing inventory management directly impacts your cash conversion cycle by reducing the time capital remains tied up in unsold goods. Effective practices balance product availability with financial efficiency.

Strong inventory management strategies focus on:

• Implement just-in-time systems: Receive goods only when needed for production or sales to minimize holding costs.
• Classify inventory strategically: Use ABC analysis to identify which items require tighter control based on value and turnover rate.
• Set optimal inventory levels: Establish minimum and maximum thresholds based on demand patterns and lead times.
• Review slow-moving items: Regularly identify and liquidate underperforming inventory to free up capital and storage space.
• Discontinuing low-demand product lines: Eliminate products with low sales volumes to reduce carrying costs and improve overall profitability.

Accurate demand forecasting prevents excess inventory accumulation by analyzing historical sales data, seasonal patterns, and market trends. By collaborating across departments—from sales to operations to finance—you can develop more precise predictions and reduce buffer stock requirements.

Accelerating inventory turnover requires a focus on product velocity throughout your supply chain. Streamlined production processes, strategic vendor relationships, and data-driven purchasing decisions all contribute to lower DIO and improved cash flow.

Read the blog → Is accounts receivable debit or credit?

Billtrust offers solutions that directly address key components of your cash conversion cycle, with our Cash Application solution leading the way. This AI-powered platform automates the matching of payments to invoices, dramatically reducing the time between receipt and application of funds. Cash Application dramatically improves payment matching accuracy, achieving match rates over 90% and up to 99% when using Billtrust Payments.

Cash Application's core capabilities include:

• Intelligent matching: Machine learning algorithms automatically connect payments with corresponding invoices at industry-leading accuracy rates.
• Automated remittance capture: Payment information is extracted from diverse sources without manual intervention.
• Exception handling: Staff can focus on resolving complex cases rather than routine matching.
• Analytics: Provides granular match rate data to identify discrepancies and pinpoint bad payors.

These capabilities directly reduce your DSO by accelerating payment processing and application. The faster you apply cash, the more accurate your receivables data becomes, allowing for more effective collections efforts on truly outstanding balances.

Beyond Cash Application, Billtrust's integrated solutions work together to optimize your entire cash conversion cycle. Our Invoicing solution accelerates delivery through multiple channels, Collections prioritizes accounts using AI-driven workflows, and Payments provides flexible options that make it easier for customers to pay you.

Together, these solutions create measurable improvements in your cash conversion cycle by targeting the most critical component—days sales outstanding—while providing the visibility and control you need to continuously optimize performance.