The cycle in days, the cash in each day, and why a day of inventory or payables is worth less than a day of receivables.
The cash conversion cycle is days sales outstanding plus days inventory outstanding minus days payables outstanding, with DSO measured on revenue and DIO and DPO on cost of goods sold. An illustrative portfolio company at 60, 80 and 45 days runs a 95-day cycle and ties up 44.38 million of working capital. A plan that cuts the cycle by 20 days releases 7.67 million, not the 10.96 million you get by valuing every day at revenue divided by 365.
Worked in full in The Private Equity Operating Partner by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The cycle is the number of days between paying a supplier and collecting from the customer, and it is one of the first numbers an operating partner asks for in the first hundred days. It is also routinely converted into cash the wrong way, because a day of inventory or payables is a day of cost, not a day of sales. In a business with a 40 per cent gross margin, valuing an inventory or payables day as a day of sales overstates it by 40 per cent of a day of sales.
| Input | Value |
|---|---|
| Revenue | 200.0 |
| Cost of goods sold | 120.0 |
| Trade receivables | 32.88 |
| Inventory | 26.30 |
| Trade payables | 14.79 |
| Trade working capital | 44.38 |
Gross margin is 40 per cent. Balances are year-end figures; where the business is seasonal, use an average of the twelve month-ends instead, or the cycle will describe the balance sheet date rather than the business.
DSO = receivables ÷ revenue × 365 = 32.88 ÷ 200.0 × 365 = 60.0 days
DIO = inventory ÷ COGS × 365 = 26.30 ÷ 120.0 × 365 = 80.0 days
DPO = payables ÷ COGS × 365 = 14.79 ÷ 120.0 × 365 = 45.0 days
CCC = DSO + DIO − DPO = 60 + 80 − 45 = 95 days
In Excel, with receivables, inventory and payables in B1:B3 and revenue and COGS in B4:B5: =B1/B4*365+B2/B5*365-B3/B5*365.
Each day count uses the flow that matches the balance. Receivables are invoiced at selling price, so they are divided by revenue. Inventory and payables sit at cost, so they are divided by cost of goods sold. Mixing the two bases is the most common error in the calculation, and it is worth seeing what it does.
One day of DSO is revenue over 365: 0.548 million. One day of DIO or DPO is COGS over 365: 0.329 million. The cycle is a sum of days of different sizes, so it cannot be turned into cash with a single conversion factor.
| Lever | Value of one day | 10 days | 20 days |
|---|---|---|---|
| Collect faster (DSO) | 0.548 | 5.48 | 10.96 |
| Hold less stock (DIO) | 0.329 | 3.29 | 6.58 |
| Pay later (DPO) | 0.329 | 3.29 | 6.58 |
The working capital plan agreed with management takes 5 days off DSO through invoicing on delivery, 10 days off DIO by cutting slow-moving lines, and adds 5 days of DPO by moving suppliers onto the contract terms. The cycle falls from 95 to 75 days.
| Lever | Days | Value per day | Cash released |
|---|---|---|---|
| DSO from 60 to 55 | 5 | 0.548 | 2.74 |
| DIO from 80 to 70 | 10 | 0.329 | 3.29 |
| DPO from 45 to 50 | 5 | 0.329 | 1.64 |
| Total | 20 | 7.67 |
Working capital falls from 44.38 to 36.71 million. The release happens once, as the balances move to their new level, and from then on the business simply carries less capital. At an 8 per cent cost of debt the cash, applied to the term loan, saves about 0.61 million of interest a year.
The shortcut overstates the release by 43 per cent. Twenty days at 0.548 million gives 10.96 million. That is only right if all twenty days come from receivables. Fifteen of the twenty in this plan come from inventory and payables, where a day is worth 0.329 million, so the true figure is 7.67 million and the shortcut is 3.29 million too high.
The gap between a day of revenue and a day of cost is the gross margin, so the higher the margin, the less a day of inventory or payables is worth. Holding revenue at 200.0 and the same 5, 10 and 5 day plan:
| Gross margin | COGS | Plan cash | Shortcut | Plan as % of shortcut |
|---|---|---|---|---|
| 30% | 140.0 | 8.49 | 10.96 | 78% |
| 40% | 120.0 | 7.67 | 10.96 | 70% |
| 50% | 100.0 | 6.85 | 10.96 | 62% |
| 60% | 80.0 | 6.03 | 10.96 | 55% |
In a 60 per cent margin business a day of stock is worth only 40 per cent of a day of sales, and a plan built mostly on inventory delivers barely half of what a days-times-revenue slide promises.
Compute DSO on revenue and DIO and DPO on cost, add them as days, and convert each lever into cash with its own value per day. On this company 20 days are worth 7.67 million, not 10.96, and the difference is the gross margin. The Private Equity Operating Partner treats working capital as one of the buckets of the value creation bridge, alongside the operating work and deleveraging, and the free workbook for this case shows how cash released from the balance sheet flows into the deleveraging bucket rather than into EBITDA.
Because inventory and payables are carried at cost, so the days they represent are days of cost. Dividing 26.30 of inventory by revenue instead of COGS gives 48.0 days instead of 80.0, and the cycle falls from 95 to 81 days. The cash is the same either way; only the day count changes, which is why two advisers can report different cycles for the same balance sheet.
There is no universal level: a software company can run negative days and a distributor or manufacturer 60 to 120. What matters is the trend against the company's own history and peers in the same sector. In the illustrative case, 95 days ties up 22.2 per cent of revenue, so each 10 per cent of growth absorbs 4.44 million of cash before any capex.
No. It is a one-off release, worth its face value once plus the interest it saves, not a recurring earnings stream. The 7.67 million in the example saves about 0.61 million a year at 8 per cent, while putting it through a 10.0x multiple would claim 76.7 million that no buyer will pay for.
This article is one calculation from The Private Equity Operating Partner. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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