Working capital calculator and cash conversion cycle

Working capital or the cash conversion cycle: what does this calculator add?

Working capital is a balance sheet amount: current assets - current liabilities. For the default business, $950,000 - $520,000 = $430,000, and the current ratio is 950,000 / 520,000 = 1.83:1. Both describe one date. Neither tells you how long cash is locked up in stock and unpaid invoices, or what it would be worth to unlock it.

That is what the cash conversion cycle does. It converts inventory, receivables and payables into days and nets them: CCC = inventory days + receivable days - payable days. This page then puts a cash value on each day and, in the Release cash tab, works out the cash that new target days would free and the interest that saves. For a broader set of liquidity, profitability and gearing measures from the same accounts, the financial ratio calculator covers those.

How do you calculate the cash conversion cycle?

Work out one day of trading first, then express each balance as a number of those days. The default business has revenue of $3,650,000 and cost of sales of $2,555,000, so one day of sales is $10,000 and one day of cost of sales is $7,000 on a 365-day year.

Read it as a timeline. Goods sit in the warehouse for 60 days, customers take 45 days to pay, and the supplier is paid after 40 days. So from paying the supplier to collecting from the customer, 65 days pass in which the business has funded the goods itself, a little over nine weeks.

How much cash does each day of the cycle tie up?

Each day of the cycle is a day of goods the business has already paid for. Valued at cost, that is one day of cost of sales: $7,000 for the default figures. Shortening the cycle by a single day frees roughly that much. A day of receivables is worth more, $10,000, because customers owe the selling price, margin included.

The cash actually held in the cycle is net trade working capital = inventory + receivables - payables = $420,000 + $450,000 - $280,000 = $590,000. Multiplying the 65-day cycle by $7,000 gives only $455,000, and the gap is the profit margin sitting inside receivables. Use the balance sheet figure when you need the total and the per-day figure when you need the effect of a change of a few days.

How much cash does shortening the cycle release?

Convert each target back into a balance with the same daily figures, then compare with today's balance. Suppose the default business aims for 50 inventory days, 35 receivable days and 45 payable days, and the cash would reduce an overdraft costing 8% a year:

1. Inventory: 50 x $7,000 = $350,000, releasing $420,000 - $350,000 = $70,000.
2. Receivables: 35 x $10,000 = $350,000, releasing $450,000 - $350,000 = $100,000.
3. Payables: 45 x $7,000 = $315,000, keeping $315,000 - $280,000 = $35,000 more cash in the business.
4. Cash released = $70,000 + $100,000 + $35,000 = $205,000, and the cycle falls from 65 to 40 days.
5. Annual finance cost saved = $205,000 x 8% = $16,400.

In a full credit policy question the saving is then set against what the change costs: early settlement discounts offered to customers, lost sales from tighter terms, or a supplier's early payment discount given up by paying later.

Working capital example in pounds: tightening credit terms

A UK distributor has revenue of £1,460,000 and cost of sales of £1,095,000, so a day of sales is £4,000 and a day of cost is £3,000. It holds £150,000 of inventory (50 days), £240,000 of receivables (60 days) and £90,000 of payables (30 days), an 80-day cycle.

If it brings customers down to 45 days and changes nothing else, receivables fall to 45 x £4,000 = £180,000. That releases £60,000, the cycle shortens to 65 days, and at an overdraft rate of 6% the interest saved is £3,600 a year. Enter the same figures in the Release cash tab, keeping inventory at 50 and payables at 30 days, to see each line of the working.

Can the cash conversion cycle be negative?

Yes, and in some businesses it normally is. A retailer in Dubai, working in AED, takes AED 7,300,000 a year, almost all paid at the till, with cost of sales of AED 5,475,000. It holds AED 300,000 of stock, AED 40,000 of receivables and owes suppliers AED 675,000.

1. Inventory days = 300,000 / 5,475,000 x 365 = 20.
2. Receivable days = 40,000 / 7,300,000 x 365 = 2.
3. Payable days = 675,000 / 5,475,000 x 365 = 45.
4. Cycle = 20 + 2 - 45 = -23 days.

Customers have paid more than three weeks before the supplier is due, so net trade working capital is negative, AED -335,000: suppliers are funding the business. The flip side is exposure. If sales fall, cash coming in drops at once while bills for earlier, larger purchases still fall due.

How do you calculate working capital and the cash conversion cycle in Excel?

With current assets in B1, current liabilities in B2, revenue in B3, cost of sales in B4, inventory in B5, receivables in B6 and payables in B7:

• Working capital =B1-B2.
• Inventory days in C5 =B5/B4*365, receivable days in C6 =B6/B3*365, payable days in C7 =B7/B4*365.
• Cash conversion cycle =C5+C6-C7.
• Cash released by a target receivable figure in D6 =B6-D6*B3/365, and its yearly interest value =(B6-D6*B3/365)*8%.

For the default inputs the cycle cell returns 65 and the receivables release at 35 days returns 100,000. Swap 365 for 360 if your course or lender counts that way. Google Sheets accepts the same formulas.

What lengthens or shortens the cycle?

Inventory. Slow-moving lines, bulk buying and long production runs add days; ordering closer to demand removes them, at the risk of running out. Receivables. Generous credit terms, slow invoicing and weak collection add days; settlement discounts and prompt chasing cut them. Payables. Paying later shortens the cycle, but only inside agreed terms, and it may mean giving up early payment discounts or goodwill. Growth. A business that grows quickly needs more working capital even with an unchanged cycle, because every day is worth more. When sales outgrow the finance available, the result is overtrading: a profitable business that runs out of cash.

Common working capital mistakes

• Using revenue for inventory and payable days. Both are at cost, so they divide by cost of sales; only receivables use revenue.
• Adding payable days instead of subtracting them. Supplier credit shortens the time the business funds itself.
• Valuing a day of the cycle at sales. Cash tied up in inventory is at cost; only receivables carry the margin.
• Counting a release twice. Cash freed once is a one-off; the yearly benefit is the interest on it.
• Ignoring the cost of the change. Discounts, lost sales and supplier relations belong in the same comparison.
• Reading one date as typical. Seasonal businesses can show a very different cycle at the year end.

What the working capital calculator leaves out, and a glossary

The calculator uses year-end balances and treats all revenue as credit sales and all cost of sales as credit purchases. It does not split inventory into raw materials, work in progress and finished goods, model cash flow month by month, or value the cost of a discount or lost sales. For the ordering side of inventory, the EOQ calculator finds the order size that keeps ordering and holding costs lowest.

Working capital: current assets less current liabilities. Cash conversion cycle: inventory days plus receivable days less payable days, also called the cash operating cycle or working capital cycle. Net trade working capital: inventory plus trade receivables less trade payables. Inventory days: how long stock is held, at cost. Receivable days: how long customers take to pay. Payable days: how long the business takes to pay suppliers. Overtrading: growing faster than the working capital available to fund it.

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