—Guide
The Cash Conversion Cycle Explained: How to Free Up Working Capital
What the cash conversion cycle is, how to calculate it, and practical ways to shorten it by collecting faster, holding less stock and managing payables.
The cash conversion cycle measures how long money is tied up between paying for inputs and collecting from customers. Shortening it releases cash without borrowing more. This guide explains how to measure and improve it.
The Three Parts
- Receivable days: how long customers take to pay. Receivables ÷ sales × 365.
- Inventory days: how long stock is held. Inventory ÷ cost of goods sold × 365.
- Payable days: how long you take to pay suppliers. Payables ÷ purchases × 365.
Cash conversion cycle = receivable days + inventory days − payable days.
An Example
A business with 60 receivable days, 45 inventory days and 30 payable days has a 75-day cycle. If annual sales are ₹12 crore, every day of the cycle represents roughly ₹3.3 lakh of cash tied up. Cutting the cycle by 20 days frees up around ₹66 lakh.
Reducing Receivable Days
- Set clear credit terms and check new customers' creditworthiness.
- Invoice immediately and accurately.
- Follow up before invoices fall due.
- Offer early payment incentives where margins allow.
- Use invoice discounting where appropriate.
Reducing Inventory Days
- Set reorder levels based on actual demand.
- Cut slow-moving products.
- Clear old stock before it becomes obsolete.
- Work with suppliers on shorter lead times.
Managing Payable Days
- Negotiate terms that match your cycle.
- Pay on the due date, not early.
- Remember that micro and small enterprise suppliers must be paid within 45 days, with legal and tax consequences if not.
Track It Monthly
Measure the cycle every month, by product line or customer group if possible, and review it with the sales and operations teams.
Getting Help
Think Filing helps businesses measure and shorten their cash conversion cycle.