What is the cash conversion cycle, and how is it calculated from DSO, DIO, and DPO?
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
The answer
The cash conversion cycle is the net number of days my cash is tied up funding the operating cycle, and it is calculated as Days Sales Outstanding plus Days Inventory Outstanding minus Days Payable Outstanding. DSO, or receivables divided by revenue times 365, tells me how many days on average my customers take to pay me. DIO, inventory over cost of goods sold times 365, tells me how long inventory sits before it gets sold.
DPO, payables over cost of goods sold times 365, tells me how long I take to pay my suppliers. I add the days I am waiting on customers and holding inventory, then subtract the days I am holding onto my suppliers’ cash, because that financing offsets the outflows. A lower or negative cycle means faster cash generation from operations.
In forecasting, I use these ratios to project balance sheet balances from revenue and cost assumptions, and the period-over-period change in net working capital flows into my cash flow build.
Cash conversion cycle
| Days sales outstanding (DSO) | 45 days |
| + Days inventory outstanding (DIO) | 60 days |
| − Days payables outstanding (DPO) | 35 days |
| Cash conversion cycle | 70 days |
Also asked as
- Define net working capital and explain why cash and debt are excluded from the calculation.
- If net working capital increases year over year, is that a source or use of cash? Explain the intuition.
- Define DSO, DIO, and DPO, and explain what each measures.
- Explain why a company might have negative working capital, and why that can be a competitive advantage rather than a warning sign.
- How would you forecast a company's accounts receivable balance for next year using DSO, rather than growing the dollar balance by a flat percentage?
- Explain what a working-capital peg is in an M&A purchase agreement and why buyers and sellers negotiate over its definition.
- A company's Year 1 working capital lines are AR $55, Inventory $80, Prepaid expenses $6, AP $40, Accrued expenses $14, Deferred revenue $9. In Year 2: AR $62, Inventory $70, Prepaid expenses $7, AP $48, Accrued expenses $16, Deferred revenue $14. Calculate NWC in each year and the change, and identify which single line item most drove the result.
- A company has current-year revenue of $800 and DSO of 65 days. Next year, revenue is forecast to grow to $860 and management plans to reduce DSO to 55 days. Compute current-year AR, next-year AR, the total change, and decompose the change into the portion caused by revenue growth versus the portion caused by the DSO improvement.
- A target's trailing average NWC peg is $150. At the proposed closing date, reported balances are AR $110, Inventory $160, Prepaid expenses $8, AP $90, Accrued expenses $20, Deferred revenue $18. You learn the seller delayed $30 of normal supplier payments (understating true AP by $30) specifically to inflate the reported NWC before closing. Compute the reported closing NWC, the normalized closing NWC, and the purchase price adjustment implied by each versus the peg.
Practice this topic with rubric-grounded grading inside IB Atlas.
Start freeGet all 125 practice prompts as one PDF.
General educational prompts with study explanations for offline review. They are not firm-provided or confidential questions.
Keep going
- Why does cash increase, not decrease, when depreciation increases, assuming a positive tax rate?
- What is deferred revenue, which side of the balance sheet does it sit on, and why?
- Explain the three hard linkages between the three financial statements.
- Explain FIFO and LIFO. In a period of rising prices, which method produces higher reported net income, and why?
- Guide: Accounting terms study guide
The rest of this topic
Working capital and cash conversion