What it calculates

Working capital analysis measures how long cash is tied up in the operating cycle using days sales outstanding, days inventory outstanding and days payables outstanding, combined into the cash conversion cycle.

How it is calculated

DSO is receivables divided by revenue times the days in the period: how long customers take to pay. DIO is inventory divided by cost of goods sold times days: how long stock sits. DPO is payables divided by COGS times days: how long you take to pay suppliers. The cash conversion cycle is DSO plus DIO minus DPO - the number of days between paying for inputs and collecting from customers.

How to read the result

A shorter cycle frees cash without any change in profitability, which is why working capital is the cheapest source of funding available to most businesses. A negative cycle, where customers pay before suppliers are due, means growth generates cash rather than consuming it. Track the trend rather than the level, since sector norms vary hugely. Rising DSO with flat revenue is an early warning of collection problems or of channel stuffing, and both usually show here before they show in profit.

Worked example

Revenue of 50,000,000, COGS of 30,000,000, receivables of 8,200,000, inventory of 4,900,000 and payables of 5,600,000 over a 365-day year gives DSO of 59.9, DIO of 59.6 and DPO of 68.1. The cash conversion cycle is 51.4 days. Cutting DSO by ten days releases about 1,370,000 of cash.

Common questions

Is a negative cash conversion cycle always good?

It is a strong position, common in retail and subscription businesses, but it depends on how it was achieved. Reached by stretching suppliers it is fragile - suppliers eventually reprice or tighten terms. Reached by collecting upfront it is genuinely durable.

Should DPO be maximised?

Only up to the point where relationships and pricing suffer. Paying late forfeits early-settlement discounts, which are often worth far more annualised than the cash is worth to you, and it eventually costs you priority when supply is constrained.

Why use COGS rather than revenue for DIO and DPO?

Because inventory and trade payables are both carried at cost, not at selling price. Using revenue would mix a cost-based numerator with a margin-inclusive denominator and understate both metrics by roughly the gross margin.