Finance

Working Capital Management - The Cash Conversion Cycle

Finance Guy

Finance Guy

— 3 min read

Working capital is the lifeblood of any business.

It’s the difference between a company’s current assets (cash, inventory, accounts receivable) and current liabilities (accounts payable, short-term debt).

Effective working capital management ensures a business can meet its short-term obligations while funding day-to-day operations.

At the heart of this process lies the Cash Conversion Cycle (CCC)—a metric that reveals how efficiently a company converts inventory and resources into cash.

In this post, we’ll break down the CCC, its components (inventory days, debtor days, creditor days), and strategies to optimize working capital.

What is the Cash Conversion Cycle (CCC)?

The CCC measures the time it takes for a company to turn its investments in inventory and other resources into cash from sales.

The shorter the cycle, the less time capital is tied up, improving liquidity.

Formula:

CCC = Inventory Days + Debtor Days − Creditor Days

Let’s unpack each component:

1. Inventory Days: How Long Stock Sits on Shelves

Inventory Days measures the average time inventory is held before being sold.

Formula:

Inventory Days = (Average Inventory / Cost of Goods Sold (COGS)) × 365

Example:

  • Average Inventory = $500,000
  • COGS = $2,000,000
  • Inventory Days = 500,000 / 2,000,000 × 365 = 91 days

What It Tells You:

  • High inventory days = Overstocking, obsolescence risk, or slow sales.
  • Low inventory days = Efficient turnover but risk of stockouts.

Optimization Strategies:

  • Just-in-Time (JIT) Inventory: Align orders with demand.
  • Forecasting: Use historical data to predict sales trends.
  • Liquidate Slow-Moving Stock: Discounts or bulk sales.

2. Debtor Days: How Fast Customers Pay

Debtor Days (or Accounts Receivable Days) measures the average time customers take to pay invoices.

Formula:

Debtor Days = (Accounts Receivable / Revenue) × 365

Example:

  • Accounts Receivable = $300,000
  • Annual Revenue = $3,000,000
  • Debtor Days = 300,000 / 3,000,000 × 365 =36.5 days

What It Tells You:

  • High debtor days = Poor collections or lenient credit terms.
  • Low debtor days = Strong collections or cash-on-delivery policies.

Optimization Strategies:

  • Tighten Credit Policies: Vet customers’ creditworthiness.
  • Early Payment Discounts: Offer 2% off for payment within 10 days.
  • Automate Invoicing: Use software to track and remind customers.

3. Creditor Days: How Long You Take to Pay Suppliers

Creditor Days (or Accounts Payable Days) measures the average time a company takes to pay its suppliers.

Formula:

Creditor Days = (Accounts Payable / COGS) × 365

Example:

  • Accounts Payable = $400,000
  • COGS = $2,000,000
  • Creditor Days = 400,000 / 2,000,000 × 365 = 73 days

What It Tells You:

  • High creditor days = Leveraging supplier credit to preserve cash.
  • Low creditor days = Paying suppliers quickly (may strain liquidity).

Optimization Strategies:

  • Negotiate Better Terms: Extend payment deadlines with suppliers.
  • Balance Timing: Align payables with receivables to avoid cash gaps.

Putting It All Together: The Cash Conversion Cycle

Let’s calculate the CCC using our examples:

  • Inventory Days = 91 days
  • Debtor Days = 36.5 days
  • Creditor Days = 73 days

CCC = 91 + 36.5 −73 = 54.5 days

Interpretation:
It takes the company 54.5 days to convert inventory investments into cash. A shorter CCC means faster cash generation, reducing the need for external financing.

Why the CCC Matters

  1. Liquidity: A shorter cycle frees up cash for growth or emergencies.
  2. Profitability: Less capital tied up = lower interest costs.
  3. Competitive Edge: Efficient companies can reinvest cash faster.

Case Study: Improving the CCC

Company A (CCC = 70 days) implemented these changes:

  • Reduced inventory days from 90 to 75 by adopting JIT.
  • Lowered debtor days from 45 to 30 with stricter credit terms.
  • Extended creditor days from 40 to 50 through supplier negotiations.

New CCC:

75 + 30 − 50 = 55 days

Result: Freed up 1.5M in cash, reducing borrowing costs by 75k annually.

Common Pitfalls in Working Capital Management

  1. Over-Optimizing One Component: Cutting inventory too aggressively risks stockouts.
  2. Ignoring Supplier Relationships: Delaying payments too long may harm trust.
  3. Neglecting Seasonality: CCC can fluctuate—plan for peak demand periods.

Tools to Manage Working Capital

  • ERP Systems: Automate inventory, receivables, and payables tracking.
  • Cash Flow Forecasts: Predict short-term liquidity needs.
  • Key Metrics: Monitor CCC, current ratio, and quick ratio.

Conclusion
Working capital management isn’t just about survival—it’s about strategic growth.

By optimizing inventory, receivables, and payables, businesses can unlock cash trapped in operations, reduce reliance on debt, and invest in innovation.

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