Understanding the Cash Conversion Cycle in Finance

“The business has $250K in cash—why do I need more for working capital?” That’s what a new buyer asked me last week. Fair question. But here’s the thing: Working capital isn’t just about what’s in the bank. It’s about the timing of cash in vs. cash out. And that looks VERY different depending on the business. 🛠 HVAC? You might buy parts upfront, finish the job weeks later, and THEN invoice. Net-30 if you’re lucky. 👨💻 eCom? Customer pays immediately. Credit cards settle in a day or two. Super tight cycle. 👷♂️ Staffing or B2B services? Payroll every 2 weeks. Clients pay in 60. That gap? That’s your problem now. That’s the cash conversion cycle. And if you don’t plan for it, it’ll punch you in the mouth after closing. 👉 This is why working capital matters. 👉 This is why a “profitable” business can still run out of cash. So no, that $500K doesn’t mean you’re safe. You need to understand: ✅ How much goes out before cash comes in ✅ How fast the receivables turn ✅ If you need a line of credit, or if retained earnings will do the job And remember… 📉 The bank might not finance working capital. 📅 The seller might forget to warn you. 😬 But once you own it—it’s on you. Before you close, ask this: Can this business survive the gap between invoices and income—without me writing personal checks?

The client owes you $100K. You owe vendors $50K. Both are due this Friday. Guess what usually happens? The client pays late. The vendors want their money now. This is the AR/AP trap nobody warns you about. The reality for most mid-market companies: → Average AR days: 47 → Average AP days: 30 → Cash flow gap: 17 days of operational funding needed This silent cash flow gap creates a perpetual working capital shortage that worsens as you grow. As a CFO, I see it all the time: Businesses focus on sales and margins, but neglect the timing gap between collections and disbursements. And often, this timing gap is bigger than their profit margin. The quantifiable impact: - Each day of AR improvement = 1% annual cash flow boost - Missing 2% early payment discounts = 24% lost annualized return - Damaged vendor relationships = higher costs and tougher terms The liquidity equation is simple: → Beginning cash + collections - disbursements = ending cash But execution is where businesses fail. Top-performing companies do this differently: - Enforce clear invoice terms - Start systematic collections before the due date.  - Implement strategic vendor payment scheduling - Track cash conversion cycle metrics at the executive level. Cash flow management isn’t bookkeeping. It’s a strategic weapon for building enterprise value. What specific cash flow gap is holding your company back? Follow Amit Kumar for more insights on accounting and finance. #accountspayable  #finance  #accountsreceivable

Cash Flow Formulas 🏦 Cash flow is EVERYTHING in business. It doesn't matter how much profit you show on paper...if you can't manage cash, you won't survive. Let's break down the essential formulas you need to know 👇 ➡️ BASIC CASH FLOW • BASIC OCF 💡 Shows your true operational cash generation. Strips away all accounting entries to reveal pure cash movement in your core business operations. 🔢 Net Income + Depreciation & Amortization - Changes in Working Capital • DETAILED OCF 💡 Captures every non-cash movement in your business. Works like Basic OCF but gives you a complete picture by factoring in ALL items affecting your cash position. 🔢 Net Income + D&A + Non-cash Items ± Changes in Working Capital • DIRECT METHOD OCF 💡 Tracks pure cash movement through operations. Perfect for businesses wanting to see raw cash flows without accounting complexity. 🔢 Cash from Customers - Cash Paid to Suppliers - Operating Expenses - Taxes • BASIC FCF 💡 Reveals cash available for growth. Essential for understanding exactly how much money you have for expansion after covering all operational needs. 🔢 Operating Cash Flow - Capital Expenditures ➡️ EFFICIENCY METRICS • CASH CONVERSION CYCLE 💡 Measures how fast you turn operations into cash. Combines three critical metrics to show your complete cash efficiency story. 🔢 DIO + DSO - DPO • DAYS INVENTORY OUTSTANDING 💡 Shows inventory efficiency. Lower numbers win unless you're strategically stocking up for high-demand periods. 🔢 (Average Inventory ÷ COGS) × 365 • DAYS SALES OUTSTANDING 💡 Reveals collection speed. The true test of how well your collection process works and how quickly customers actually pay. 🔢 (Average AR ÷ Revenue) × 365 • DAYS PAYABLE OUTSTANDING 💡 Tracks payment timing. Balances cash preservation with maintaining strong supplier relationships. 🔢 (Average AP ÷ COGS) × 365 ➡️ RETURN METRICS • CASH FLOW ROI 💡 Measures return on cash investments. Critical for evaluating project success and making investment decisions. 🔢 Cash Flow from Operations ÷ Investment • CASH FLOW ROA 💡 Shows asset efficiency. Essential for asset-heavy businesses to evaluate their operational performance. 🔢 Operating Cash Flow ÷ Average Total Assets • CASH FLOW ROE 💡 Reveals shareholder returns. Crucial for public companies and fundraising efforts to demonstrate value creation. 🔢 Operating Cash Flow ÷ Average Stockholders' Equity ➡️ WORKING CAPITAL • NET WORKING CAPITAL 💡 Shows operational liquidity. The foundational metric that answers whether you can keep the business running smoothly. 🔢 Current Assets - Current Liabilities • OPERATING WORKING CAPITAL 💡 Measures core business efficiency. Excludes cash and debt to focus purely on operational performance. 🔢 Current Assets (exc. cash) - Current Liabilities (exc. debt) === These formulas drive smart business decisions. Which cash flow metric are you using the most? Drop your insights below 👇