Cash Conversion Cycle: a Worked Example

The cash conversion cycle is the number of days a company's own cash is trapped between paying for inputs and collecting from customers:

Debtor days: how long customers take to pay. Inventory days: how long stock sits before it sells. Payables days: how long the company takes to pay its own suppliers — subtracted, because during those days the suppliers are funding the business. The result is the length of the gap the company has to finance out of its own cash or a bank facility, every day, at whatever size it currently trades. The glossary entry defines the term the way a credit desk uses it; this page runs the actual numbers.

Take a food distributor — constructed for this page, like every figure on this site — with revenue of US$20.0m. Customers pay in 47 days, stock turns in 63, suppliers are paid in 34:

That US$4.16m is not a forecast and not a ratio — it is the cash this business has standing in the gap between paying and collecting, at today's size, on today's terms. It is the number a working capital limit exists to fund.

In year two, revenue has grown to US$26.0m — up 30%, a good story. But the terms have drifted: debtors 52 days, inventory 70, payables 31.

The business now carries roughly US$2.3m more working capital than it did two years ago. The decomposition is the part a lender actually reads: had the cycle held at 76 days, growth alone would have absorbed about US$1.25m — the honest cost of a bigger business. The other US$1.07m is the drift from 76 to 91 days: slower collections, heavier stock, less supplier patience. Half the absorption is growth. Half is deterioration wearing growth's clothes.

Now suppose this borrower asks for a US$1.5m increase to the facility. The arithmetic makes the request legible before a single meeting: US$2.3m has already been absorbed, so the request is not funding the future — it is catching up with the past, and it is not even the whole of it. The conversation that follows is not “yes or no to US$1.5m” but “which half of the absorption are we financing — the growth, or the drift?” Fund the first willingly. The second, the borrower should be fixing, not funding.

The arithmetic above uses revenue as the single scalar for all three components, because a credit desk needs a size before it needs precision. The strict convention applies each component to the base it is measured on: debtor days to revenue, inventory days and payables days to cost of sales. Give the distributor a cost of sales of 80% of revenue — US$16.0m in the first year, US$20.8m in the second — and the same two years read:

Absorbed across the two years: about US$2.08m, against US$2.3m on the quick version. Hold the terms at 47, 63 and 34 days on the second year's base and growth alone would carry US$5.00m — so roughly US$1.15m of the absorption is the cost of a bigger business and US$0.93m is the drift. The decomposition lands in the same place as before: about half growth, about half deterioration, and a US$1.5m request that is still catching up with the past.

Use the strict version when the numbers will be written down — a credit paper, a covenant, a borrowing base — and when margin is thin or moving, because that is when the two versions diverge most. Use the quick version in the meeting. The reading is the same either way; what changes is whether the arithmetic survives a reviewer who checks it.

The level of the cycle mostly reflects the business model. The movement reflects management, and each component moves for its own reasons. Debtor days lengthening can be growth into slower-paying customers, a large customer imposing terms, or collections quietly losing discipline — three different conversations. Inventory days lengthening can be a deliberate build for a season or contract, or stock that has stopped selling and not yet been admitted to. Payables days shortening — suppliers tightening terms — is one of the quietest early warnings in the set, because suppliers often read distress before banks do.

This is why a credit desk never reads the cycle as one number. The same 91 days made of clean growth and negotiated terms is a financing request; made of drift on all three lines, it is a management question the facility increase would only postpone.

The cycle's real work is catching the most seductive pattern in commercial lending: revenue up, profit up, cash quietly gone. Growth absorbs working capital arithmetically — every extra dollar of revenue carries its share of the cycle — so a growing business can be profitable on paper and starving in the bank account, and the facility request that follows looks like success right up until the numbers are run.

The two published files that work this pattern from opposite ends: Issue 01, where the request covers less than a third of the absorption already in the numbers and the senior read is to decline as framed, and Issue 04, its mirror — the same request shape where the cycle held, the arithmetic supports it, and the disciplined answer is a fast, full yes. The pair is the point: the cycle does not make lenders cautious. It makes them accurate.

The Three Diagnostics calculator runs this reading — growth quality, cash conversion, and the trend in the cycle — against twelve numbers you enter yourself, and returns a senior banker's written read rather than a score. Where the cycle sits inside the lender's whole cash discipline is mapped in cash flow analysis for business lending, and the full reading order is worked across two opposite cases in the working capital case study, and from the borrower's side of the table in How Banks Read You.