The Cash Conversion Cycle

There is a stretch of time in every business between the money going out and the money coming back. You pay for materials, or wages, or stock. Weeks pass. The job completes, the invoice goes out, more weeks pass, and eventually the cash lands.

That gap has to be funded by somebody, and in a small business the somebody is usually you, your overdraft, or your suppliers. The cash conversion cycle is simply the length of that gap in days, and it is the number that explains why growth so often feels like being punished.

What the model is

Three components, one subtraction.

Stock days. How long you hold materials or goods before they are sold. Stock divided by cost of sales, times 365.

Debtor days. How long customers take to pay after you invoice. Trade debtors divided by sales, times 365.

Creditor days. How long you take to pay suppliers. Trade creditors divided by cost of sales, times 365.

Stock days plus debtor days minus creditor days gives you the cycle. It is the number of days your money is somebody else's working capital.

Why it matters to an owner

Because this number, not your profit, determines how much cash growth will demand. Every new pound of sales drags a proportion of itself into the funding gap for the length of the cycle. That is why the year you win most work is the year you feel poorest, and why a business can go under while its profit and loss looks like its best year yet.

It is also the cheapest source of finance available to you. Shortening the cycle releases cash you already own. There is no application, no interest, no personal guarantee, and no lender's view of your sector. Most owners will spend a fortnight arranging a facility and no time at all on the twenty days sitting in their aged debtor list.

A worked example

Illustrative, but the arithmetic works the same in any business. An electrical contractor turning over £1.8m. Stock 42 days, debtors 68 days, creditors 30 days. Cycle: 42 + 68 − 30 = 80 days.

As a rough rule, and it is rough, the working capital tied up is the cycle multiplied by daily revenue. £1.8m over 365 days is £4,932 a day. Eighty days of that is around £395,000 sitting in stock and in other people's bank accounts.

Now shorten it. Getting debtor days from 68 to 45 is not a heroic act. It means invoicing on completion instead of at month end, stating terms clearly on the quote, and calling the top five overdue accounts every Friday. Twenty-three days at £4,932 releases roughly £113,000 of cash, once, permanently, and it reduces the funding requirement from that point onwards. If that money was previously sitting on an overdraft at nine per cent, the saving is over £10,000 a year in interest alone, which for many businesses of that size is more than the last price rise achieved.

Then look at what growth does. Take the same business up 30 per cent to £2.34m with the cycle unchanged. Daily revenue rises to £6,411, and 80 days of that is £513,000. The business needs roughly £118,000 of additional cash to stand still at the new size, before it has bought a single extra van. Nobody sends an invoice for that. It just quietly appears as pressure.

Not every business has a positive cycle

It is worth knowing that the number can be negative, because that tells you something about the businesses that grow without funding. A supermarket sells stock in days and pays its suppliers in weeks, so it holds customers' cash before it settles its own bills. Growth generates cash rather than consuming it.

Any business can move a little way in that direction, and the moves are usually commercial rather than financial. Deposits on order. Staged payments on longer jobs. Monthly direct debit for recurring work rather than invoicing in arrears. Annual payment in advance with a modest discount attached. None of these require a lender's permission, and every one of them shortens the gap at the point where you have most leverage, which is before the work starts rather than after it has been delivered.

The reason owners resist is that asking for money up front feels like a hard conversation with a new customer. It is a considerably easier conversation than chasing the same money ninety days later, when you have already spent it on wages.

The mistake most owners make

They attack creditor days first, because it is the lever you can pull without asking anyone. Stretching suppliers from 30 days to 60 shortens your cycle immediately and costs you your position in the queue, your discounts, your priority when materials are short, and eventually your terms. It is borrowing from the people you most need on your side.

The second error is trusting the average. Debtor days of 68 might mean everyone pays at 68, or it might mean most customers pay at 30 and one large account is at 140. Those are entirely different problems with entirely different answers, and only the aged list will tell you which one you have.

The third is ignoring stock because it does not feel like money. It is money. It is money you converted into shelving, and it is usually the least examined number in the business, particularly the slow-moving lines nobody wants to write off because writing them off makes the accounts look worse.

How to apply it this week

1. Calculate the three numbers today. Take them from your last accounts or your accounting software. It is twenty minutes of work and most owners have never done it once.
2. Attack debtor days first. Invoice the day the work is finished, not at month end. That single change can take a week out of the cycle before you have chased anybody.
3. Work the aged list, not the average. Print it, take the five largest overdue balances, and call them personally this week. Email is easy to ignore and everybody knows it.
4. Change terms on new work only. Deposits, staged payments, or 14 days rather than 30. It is far easier to set terms with a new customer than to renegotiate with an old one.
5. Ring-fence the tax money separately. VAT and PAYE are not part of your working capital, however much it looks like they are sitting in the account.
6. Set a target and track it monthly. One number on the management pack. If it is not reported, it will drift back within two quarters.

The questions to sit with

• Out of 10, how confident are you that you could state your cash conversion cycle today without looking it up?
• How much cash would be released if your debtor days matched your own payment terms?
• If you won a contract tomorrow that added 30 per cent to turnover, where would the working capital come from?
• Who in your business is actually accountable for collecting the money, and how do they know if they are doing it well?

This is the core measure in Cashflow Mastery and one of the numbers that matters most in Know Your Numbers. Most owners do not have a profit problem. They have an eighty-day problem, and it only ever announces itself as a cash problem, usually about a fortnight too late to fix it calmly.