Cash Conversion Cycle: Why Do You Subtract Payable Days?
Inventory and receivables tie up cash. Payables temporarily finance operations.
Formula
Days Inventory Outstanding + Days Sales Outstanding − Days Payables Outstanding = Cash Conversion Cycle.
Inventory days
Longer inventory days generally mean cash is tied up in inventory longer.
Receivable days
Longer days sales outstanding generally mean customers take longer to pay, extending the cash cycle.
Payable days
Because supplier credit delays cash outflow, days payables outstanding is subtracted.
Tradeoffs
A shorter cycle is not automatically perfect. Cutting inventory too far can cause stockouts, and stretching suppliers too far can damage relationships or lose discounts.
The takeaway
Inventory and receivables use cash. Payables temporarily finance operations.
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FAQ
Why is DPO subtracted?
Supplier credit delays cash outflow.
Does lower DSO generally improve the cycle?
Yes.
Is negative working capital always bad?
No. Business model and operating cycle matter.