DSO, DIO, DPO and the cash conversion cycle, worked through
A business that is selling more can end the month with less cash, if customers are paying later or stock is sitting longer in the warehouse. Three measures show it: DSO, DIO and DPO.
Receivable days (DSO)
The result is roughly how many days a baht of sales takes to come back as cash. In the example, August receivables of THB 11.274m against revenue of 10.921m give a DSO of about 32 days.
Each extra day customers take ties up about one more day of revenue: roughly THB 0.352m here.
Inventory days (DIO)
The example's inventory of THB 7.646m equals about 33 days of cost of sales. Stock held longer is cash already paid out for goods that have not sold.
Read it by type of stock. The example holds trading goods, finished goods, raw materials and work in progress, and each one comes down by a different route.
Payable days (DPO)
Some companies use cost of sales instead of purchases. Either works, as long as the definition stays the same every month.
A longer DPO means the business is using its suppliers' money for longer. Stretching past agreed terms, though, costs goodwill and often price. In the sample model DPO is fixed at 30 days, so a rise in payables comes from buying more, not from paying later.
The cash conversion cycle
It counts the days the business has to fund itself, from paying a supplier to collecting from a customer. The example comes to about 35 days.
Trade working capital, receivables + inventory − payables, is the cash held in that cycle: THB 12.550m in the example.
When sales grow
DSO, DIO and DPO do not change profit. What they change is when cash comes in and goes out.
In the working capital simulator, raising sales to 130% with every day count left alone increases closing cash by THB 4.33m. The margin is wide enough for the growth to fund itself.
Keep the same growth but let customers pay in 75 days and stock sit for 70 days, and closing cash falls by 11.61m instead. The problem is not growth; it is growth arriving with a longer cash cycle.
The simulator runs on the report 09 model, which uses a different sample dataset from the figures in the sections above, so the two sets of numbers are not comparable.
Using the measures in a review
Compare DSO with the credit terms customers actually have. A DSO above those terms means some customers are paying late, and the receivables ageing shows which ones.
Set DIO targets by product. Where a stock-out loses the customer, holding more may be worth it.
In the example DSO and DIO come from month-end balances, so they move with when in the month goods were sold or received. Judge them on a trend of several months, not on one.
Common questions
Does a high DSO always mean customers are paying late?
No. Calculated from month-end balances, DSO rises when sales bunch at the end of the month even if everyone pays on time. Check the receivables ageing: only if overdue amounts are growing too have customers really slowed down.
Can the cash conversion cycle be negative?
Yes, when a business collects from customers and sells its stock before it has to pay suppliers, as a cash-sales retailer on long supplier credit can. There, the more it sells, the more cash it holds.
Read next
Figures in the articles are synthetic sample data, used to show the method. They are not a real company's results.
