The cash conversion cycle calculates the time it takes to convert inventory into cash. It is composed of three categories: days sales outstanding, days payable outstanding and days inventory outstanding. Days sales outstanding is the amount of time a company takes, on average, to collect bills. Days payable outstanding is a firm's average period of time to pay bills. Days inventory outstanding is the amount of time, on average, a firm takes to convert inventory to sales.
Calculate days inventory outstanding (DIO). Calculate DIO by dividing inventory by cost of sales, then multiply by the number of days being examined. The balance sheet has the inventory account, and the income statement has the cost of sales.
Calculate days sales outstanding (DSO). Calculate DSO by dividing accounts receivable by total credit sales, then multiply by the number of days being examined. The balance sheet has the accounts receivable account, and the income statement has the credit sales account.
Calculate days payable outstanding (DPO). Calculate DPO by dividing accounts payable by cost of sales, then multiply by the number of days being examined. The balance sheet has the accounts payable account, and the income statement has the cost of sales account.
Add DIO and DSO, then subtract DPO to arrive at the cash conversion cycle.
Carter McBride started writing in 2007 with CMBA's IP section. He has written for Bureau of National Affairs, Inc and various websites. He received a CALI Award for The Actual Impact of MasterCard's Initial Public Offering in 2008. McBride is an attorney with a Juris Doctor from Case Western Reserve University and a Master of Science in accounting from the University of Connecticut.