Cash Conversion Cycle: Unlock Hidden Capital

The Hidden Capital Problem

You’re profitable on paper. Your P&L shows healthy margins. But your bank account is always tight. You’re constantly juggling payments, waiting for customers to pay, and wondering where all the money went.

The Working Capital Trap

Many profitable businesses struggle with cash flow because they have too much capital tied up in working capital—inventory, accounts receivable, and accounts payable. This “hidden” capital could be funding growth instead.

The solution isn’t always to borrow more money or raise capital. Often, the capital you need is already in your business—it’s just locked up in your cash conversion cycle. At MMC Financial Planning, we’ve helped Malaysian SMEs unlock millions of ringgit in hidden capital by optimizing their cash conversion cycle.

Understanding the Cash Conversion Cycle

The Cash Conversion Cycle (CCC) measures how long it takes for your business to convert investments in inventory and other resources into cash from sales.

The Three Components

Days Inventory Outstanding (DIO)

How long inventory sits before sale

Days Sales Outstanding (DSO)

How long customers take to pay

Days Payable Outstanding (DPO)

How long you take to pay suppliers

The Formula:

Cash Conversion Cycle = DIO + DSO - DPO

Where:
- DIO = Days Inventory Outstanding (lower is better)
- DSO = Days Sales Outstanding (lower is better)
- DPO = Days Payable Outstanding (higher is better)

What the CCC Tells You

CCC < 30 Days

Cash flows through your business quickly
Less capital tied up in working capital
More flexibility and liquidity
Better ability to fund growth internally

Example: Retail business with fast inventory turnover and quick payments

The Impact

Reducing your CCC by just 10 days can unlock significant capital. For a business with RM5M in annual sales, a 10-day reduction frees up approximately RM137K in working capital.

Component 1: Optimizing Days Inventory Outstanding (DIO)

DIO measures how long inventory sits in your warehouse before being sold.

Calculating DIO

DIO = (Average Inventory / Cost of Goods Sold) × 365

Example:
Average Inventory: RM500K
COGS: RM3M annually
DIO = (500,000 / 3,000,000) × 365 = 61 days

What This Means: Your inventory sits for 61 days before being sold. That’s RM500K tied up for 2 months.

Strategies to Reduce DIO

Inventory Management Best Practices

1. Implement ABC Analysis

Categorize inventory by value and turnover:

A-Items: High value, high turnover (focus optimization here)
B-Items: Medium value, medium turnover
C-Items: Low value, low turnover (minimize or eliminate)

2. Just-in-Time (JIT) Inventory

Order inventory only when needed
Reduce safety stock levels
Work with suppliers for faster delivery
Use technology to track demand patterns

3. Improve Forecasting

Use historical data and trends
Account for seasonality
Monitor market conditions
Adjust orders based on actual sales

4. Liquidate Slow-Moving Stock

Identify dead inventory (no sales in 90+ days)
Discount or bundle to move it
Donate for tax benefits
Write off and free up space

Real-World Example

Component 2: Optimizing Days Sales Outstanding (DSO)

DSO measures how long it takes customers to pay you after a sale.

Calculating DSO

DSO = (Accounts Receivable / Total Credit Sales) × 365

Example:
Accounts Receivable: RM400K
Annual Credit Sales: RM6M
DSO = (400,000 / 6,000,000) × 365 = 24 days

What This Means: On average, customers take 24 days to pay. That’s RM400K tied up in receivables.

Strategies to Reduce DSO

Optimize Your Terms

Shorter Terms: Net 15 instead of Net 30 (saves 15 days)
Upfront Payments: Require deposits or prepayment
Progress Billing: Bill as work progresses, not at completion
Cash Discounts: 2% discount for payment within 10 days

Example Impact:

Current: Net 30, DSO = 35 days
Change to: Net 15, DSO = 20 days
Improvement: 15 days
Capital Freed: (15/365) × RM6M = RM247K

Quick Win

Simply sending invoices immediately (instead of waiting a week) can reduce DSO by 5-7 days. For RM6M in annual sales, that’s RM82K-115K in freed capital.

Component 3: Optimizing Days Payable Outstanding (DPO)

DPO measures how long you take to pay suppliers. Unlike DIO and DSO, you want DPO to be higher (within reason).

Calculating DPO

DPO = (Accounts Payable / Cost of Goods Sold) × 365

Example:
Accounts Payable: RM300K
COGS: RM4M annually
DPO = (300,000 / 4,000,000) × 365 = 27 days

What This Means: You’re paying suppliers, on average, 27 days after receiving goods/services. This is essentially an interest-free loan from suppliers.

Strategies to Increase DPO (Safely)

Negotiate Better Terms

1. Extend Payment Terms

Current: Net 30
Target: Net 45 or Net 60
Approach: Frame as partnership, show growth plans, offer volume commitments

2. Take Early Payment Discounts Strategically

2/10 Net 30: 2% discount for payment in 10 days
Calculate: Is 2% worth paying 20 days early?
Rule: Only take discount if cost of capital > discount rate

Example:

Discount: 2% for paying 20 days early
Annualized: (2% / 20) × 365 = 36.5% annual rate
If your cost of capital < 36.5%, take the discount
If your cost of capital > 36.5%, don’t take the discount

3. Use Supplier Credit Cards

Extend payment by 30-45 days
Earn rewards points
Build credit history
Maintain supplier relationships

Balance DPO with Relationships

The Complete Optimization Strategy

Optimizing your cash conversion cycle requires a holistic approach across all three components.

Step 1: Calculate Your Current CCC

Gathering the Data

You Need:

Average Inventory: (Beginning + Ending) / 2
Cost of Goods Sold: Annual COGS
Accounts Receivable: Average AR balance
Total Credit Sales: Annual credit sales
Accounts Payable: Average AP balance

Calculate:

DIO = (Average Inventory / COGS) × 365
DSO = (AR / Credit Sales) × 365
DPO = (AP / COGS) × 365
CCC = DIO + DSO - DPO

Benchmarking

Step 2: Identify Optimization Opportunities

Immediate Actions

Send invoices immediately
Implement automated payment reminders
Negotiate extended payment terms with suppliers
Liquidate slow-moving inventory
Review and tighten credit policies

Expected Impact: 5-10 day CCC reduction

Step 3: Calculate Capital Impact

10 Days

CCC reduction target

RM137K

Capital freed per RM5M sales (10-day reduction)

20-30 Days

Realistic optimization target

The Math:

Capital Freed = (CCC Reduction in Days / 365) × Annual Sales

Example:
Annual Sales: RM5M
CCC Reduction: 20 days
Capital Freed = (20 / 365) × 5,000,000 = RM274K

This is capital you can use for:

Growth investments
Debt reduction
Cash reserves
Strategic initiatives
Without taking on new debt!

Real-World Case Study

Supply Chain Solutions Sdn Bhd

We had RM800K tied up in working capital and were constantly struggling with cash flow despite being profitable. MMC Financial Planning helped us optimize our cash conversion cycle from 75 days to 45 days. We freed up RM330K in capital that we used to expand operations without taking on debt. The best part? Our suppliers and customers actually appreciated the more efficient processes.

Raj Kumar

Operations Director

Common Mistakes to Avoid

Avoid These Pitfalls

These mistakes can actually worsen your cash conversion cycle or damage relationships.

Over-Optimizing One Component: Focusing only on DSO while ignoring DIO
Damaging Supplier Relationships: Paying too late and losing key suppliers
Hurting Customer Relationships: Being too aggressive with collections
Ignoring Seasonality: Not accounting for seasonal variations
No Monitoring: Setting it and forgetting it—CCC needs ongoing attention
Unrealistic Targets: Setting goals that aren’t achievable
Ignoring Quality: Reducing inventory so much that you run out of stock

The MMC Approach to CCC Optimization

At MMC Financial Planning, we take a systematic approach to optimizing cash conversion cycles:

Our 4-Phase Process

Phase 1: Assessment (Week 1-2)

Calculate current CCC and components
Benchmark against industry standards
Identify optimization opportunities
Quantify potential capital impact

Phase 2: Strategy Development (Week 3-4)

Develop optimization plan for each component
Prioritize quick wins vs. strategic initiatives
Consider impact on relationships
Set realistic targets and timelines

Phase 3: Implementation (Month 2-4)

Execute quick wins immediately
Launch strategic initiatives
Monitor progress and adjust
Maintain supplier and customer relationships

Phase 4: Optimization (Ongoing)

Monthly CCC monitoring
Continuous improvement
Quarterly strategic reviews
Annual comprehensive assessment

Next Steps: Start Optimizing Your CCC

Your business likely has significant capital tied up in working capital. Here’s how to start unlocking it:

This Week

Calculate Your Current CCC: Gather data and calculate DIO, DSO, and DPO
Identify One Quick Win: Pick the easiest optimization (e.g., send invoices immediately)
Benchmark: Compare your CCC to industry standards
Set a Target: Aim for 10-15 day reduction in first 90 days

This Month

Implement Quick Wins: Execute 3-5 immediate optimizations
Start Strategic Initiatives: Begin longer-term improvements
Monitor Progress: Track CCC weekly
Communicate Changes: Inform suppliers and customers of new terms

Ready to Unlock Hidden Capital?

Don’t let working capital tie up capital you could be using for growth. Optimizing your cash conversion cycle is one of the fastest ways to improve cash flow without taking on debt.

Remember: Every day you reduce in your cash conversion cycle frees up capital. A 20-day reduction on RM5M in sales unlocks RM274K—capital that could fund growth, reduce debt, or build reserves.

Get a Free CCC Assessment

Learn About Working Capital Optimization

The Cash Conversion Cycle: How to Unlock Hidden Capital in Your Business

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