What Is the Cash Conversion Cycle? A Plain-English Guide for NZ Small Businesses
The cash conversion cycle is the number of days your cash is tied up between paying suppliers for stock and being paid by your own customers. The formula is inventory days plus debtor days minus creditor days. The shorter it is, the less of your own money is funding each sale.
What the Cash Conversion Cycle Is
Every business that buys stock or materials before it sells them has a gap between cash going out and cash coming back in. You pay a supplier, the stock sits on a shelf or in production, you sell it, and then you wait for the customer to pay. The cash conversion cycle (often shortened to CCC) puts a single number of days on that gap.
It matters because that gap has to be funded by something: your bank balance, an overdraft, or your suppliers' patience. A business with a 60-day cycle needs roughly two months of cost of sales sitting in stock and unpaid invoices at any time. Grow sales by a third and that funding need grows by a third too, which is why profitable, growing wholesalers can still run short of cash.
The Formula in Plain English
Cash Conversion Cycle = Inventory Days + Debtor Days − Creditor Days
| Part | What it measures | Formula (annual figures) |
|---|---|---|
| Inventory days (DIO) | How long stock sits before it's sold | Average inventory ÷ cost of sales × 365 |
| Debtor days (DSO) | How long customers take to pay you | Accounts receivable ÷ revenue × 365 |
| Creditor days (DPO) | How long you take to pay suppliers | Accounts payable ÷ cost of sales × 365 |
Creditor days are subtracted because they're the part of the gap your suppliers fund for you. Each of the three parts has its own guide: what debtor days are and how to calculate them, and what creditor days are and how to calculate them.
Where to find the numbers in Xero: revenue and cost of sales come from the Profit and Loss report for the year. Inventory, accounts receivable and accounts payable come from the Balance Sheet. For average inventory, add the opening and closing stock values and divide by two.
Worked Example
Example (illustrative figures): a Hamilton hardware wholesaler has annual revenue of $2,400,000 and cost of sales of $1,680,000. Its average inventory is $230,000, customers owe it $260,000, and it owes its own suppliers $175,000.
- Inventory days = $230,000 ÷ $1,680,000 × 365 = 50 days
- Debtor days = $260,000 ÷ $2,400,000 × 365 = 40 days
- Creditor days = $175,000 ÷ $1,680,000 × 365 = 38 days
- Cash conversion cycle = 50 + 40 − 38 = 52 days
At about $4,600 of cost of sales a day ($1,680,000 ÷ 365), a 52-day cycle means roughly $240,000 of the business's own cash is tied up in stock and unpaid invoices at any one time. That's the figure the bank balance or the overdraft has to cover.
How Debtor Days and Creditor Days Both Affect It
Using the same wholesaler, here's what moving each part of the cycle does to the cash tied up:
| Change | New cycle | Cash freed up (approx.) |
|---|---|---|
| Inventory days 50 → 40 | 42 days | $46,000 |
| Debtor days 40 → 30 | 42 days | $66,000 |
| Creditor days 38 → 45 | 45 days | $32,000 held for longer |
Debtor days usually free up the most cash per day saved, because they're measured against revenue rather than cost. Creditor days are the lever to treat carefully: stretching suppliers past their agreed terms shortens your cycle on paper but costs you goodwill, credit limits and sometimes the account. For how much room there really is, see how many days you should take to pay suppliers.
How to Shorten Your Cash Conversion Cycle
- Hold less slow-moving stock. Clear lines that sit for months and reorder fast sellers more often in smaller quantities.
- Invoice the day you deliver. A delivery invoiced a week late adds a week to debtor days before the terms even start.
- Tighten terms for slow payers, and follow up overdue invoices on a fixed weekly routine.
- Pay suppliers on the due date, not before, unless there's an early payment discount worth taking.
- Get paid upfront on large orders. If a customer pays in instalments through a third party that pays you in full upfront, that invoice contributes close to zero debtor days.
Customer payment terms are the biggest single lever for most suppliers. For how Net 30, EOM and the 20th of the month following each change the cycle, see how payment terms affect the cash conversion cycle. For the wider picture, start with the Cash Flow guide.
Frequently Asked Questions
What is a good cash conversion cycle for a small business?
There's no single target, because it depends on the industry. A wholesaler or manufacturer holding stock will often sit somewhere between 30 and 90 days. The more useful test is your own trend: if the number is rising year on year while sales grow, you'll need more funding just to stand still.
Can a cash conversion cycle be negative?
Yes. A negative cycle means customers pay you before you have to pay your suppliers, so suppliers are effectively funding your stock. Supermarkets and cafés paid on the spot often work this way. It's rare for a business that sells to other businesses on account.
What if my business doesn't hold any stock?
Then inventory days are zero and the cycle is simply debtor days minus creditor days. Service businesses still have a cycle, it's just driven entirely by how fast clients pay compared with how fast you pay your own bills.
Is the cash conversion cycle the same as the operating cycle?
No. The operating cycle is inventory days plus debtor days, the full time from buying stock to collecting cash. The cash conversion cycle subtracts creditor days, so it shows only the part of that time your own cash has to fund.
How often should I calculate it?
Quarterly is enough for most small businesses, using the same method each time so the trend is comparable. Work it out before a busy season too, because that's when a long cycle turns into a cash shortfall.
