Days inventory plus days receivable minus days payable

From buying a tent to banking the cash

Follow one tent through Tamarack. The company buys it from a supplier on credit. It sits in the warehouse and on the shelf for about 81 days (days inventory, lesson 9.5). It is sold on credit and the customer takes about 41 days to pay. From purchase to cash collected is therefore

$$\text{Operating cycle}=\text{Days inventory}+\text{Days receivable}=81.1+41.1=122.2\text{ days}$$

But Tamarack did not pay for the tent on day zero. It paid its supplier after about 56 days (days payable). The supplier financed the first 56 days of the cycle for free; Tamarack’s own cash was tied up only for the rest:

$$\text{Cash conversion cycle}=\text{DIO}+\text{DSO}-\text{DPO}=81.1+41.1-55.8=66.4\text{ days}$$

For about 66 days of every cycle, Tamarack has paid for goods it has not yet been paid for. Those 66 days are financed by the company’s own cash or its bank line — and the cost of that financing is the reason the CCC is the number the final asks for most. Every day cut from the cycle releases a day’s worth of cost of goods sold in cash: at 2,880 a year, about $7,900$ per day.

The sign of the payables term

The payables term is subtracted: the longer the company takes to pay, the shorter the stretch it finances itself. Adding it (DIO + DSO + DPO = 178 days) is the most common exam error, and it gets the direction of every lever wrong.

Because payables are subtracted, the CCC can be negative. A grocery chain that sells for cash (days receivable near 3), turns stock in 25 days and pays suppliers in 45 has a CCC of $25+3-45=-17$ days: its suppliers finance the whole cycle and 17 days more. The chain is running its working capital on other people’s money — which is why large retailers guard their payment terms so fiercely.

The levers, and what each costs

Three levers shorten the cycle; none is free.

• Collect faster (cut DSO). Tighter credit terms, prompt-payment discounts, firmer follow-up. Cost: customers who valued the credit may buy elsewhere; discounts are a price cut.
• Hold less inventory (cut DIO). Fewer slow lines, just-in-time replenishment, better forecasting. Cost: stock-outs and lost sales in a seasonal business; supplier minimums.
• Pay slower (raise DPO). Negotiate longer terms; use the full term rather than paying early. Cost: lost early-payment discounts; supplier goodwill, and eventually supplier terms, credit limits or willingness to supply at all.

Suppose Tamarack tightens collections to 35 days and negotiates 60-day terms with its suppliers, leaving inventory alone:

$$\text{CCC}=81.1+35-60=56.1\text{ days}$$

Ten days shorter — roughly 79,000 of cash released — at the price of some marginal customers and some supplier relationships. A recommendation that names the lever without the cost is half an answer.