Business economics
Working capital and the cash cycle
Why growing businesses run short of cash, and how to measure the days cash is tied up.
Learning objectives
- Explain why a growing business consumes cash even when it is profitable
- Calculate DSO, DIO, DPO and the cash conversion cycle
- Estimate the cash absorbed by working capital as sales grow
A business pays for stock before it sells it, and often sells before customers pay. Until the money comes back, cash is tied up in working capital: receivables and inventory, partly offset by what it owes suppliers.
The faster a business grows, the more cash this ties up. That is why fast-growing, profitable companies are among the most likely to run short of cash, and why lenders, buyers and CFOs watch the cash conversion cycle closely.
DSO = Receivables ÷ Revenue × 365 DIO = Inventory ÷ COGS × 365 DPO = Payables ÷ COGS × 365 CCC = DSO + DIO − DPO
- DSO
- days sales outstanding: how long customers take to pay
- DIO
- days inventory outstanding: how long stock sits before it is sold
- DPO
- days payables outstanding: how long the business takes to pay suppliers
- CCC
- cash conversion cycle: days between paying suppliers and collecting from customers
Included with a Formula Quest membership
The rest of this lesson is for members. Members get the full lesson, including its 3 graded exercises, and every other Finance Quest lesson.