Revenue and margin tell a buyer what a business earns. They say nothing about how long the business waits between making a sale and actually having the cash — and that waiting period, built from the target’s own receivables, inventory and payables, is what a working capital target at closing is actually pricing.
Key takeaways
A cash conversion picture has three components: how long it takes the business to collect what it is owed, how long inventory sits before it turns into a sale, and how long the business itself takes to pay its own suppliers. The first two tie up cash; the third is a source of interest-free financing from suppliers, for as long as it stays within normal terms. None of these figures needs to be estimated — they come directly from the same aging reports a buyer is already building for receivables and payables review, plus the inventory turnover implied by cost of goods sold against average inventory on hand.
A business with a short cycle turns a sale into collected cash quickly and needs comparatively little working capital to keep operating. A business with a long cycle — slow-paying customers, inventory that sits, suppliers paid promptly — needs meaningfully more cash tied up in the operating cycle to support the exact same revenue.
Deavo’s own red-flag list for reading a target’s financial statements names two of the cycle’s components directly: (accounts receivable growing faster than revenue), which can point to slower-paying customers or collection issues, and (rising inventory levels without a matching increase in sales) (deavo, reading financial statements). Neither symptom shows up as a line item labelled “problem” anywhere in the statements — both only appear when a buyer compares the growth rate of receivables or inventory against the growth rate of revenue over the same period, which is exactly what building a cash conversion picture forces a buyer to do systematically rather than by instinct.
The cash tied up in a business’s operating cycle is not an abstraction for a buyer — it is what the purchase agreement’s net working capital peg is actually funding. Buyer and seller typically agree a target working capital amount before closing, based on the business’s recent historical average (treadstonelaw, working capital adjustment), and the peg has to be set on a period that fairly represents the normal cycle — a peg “based on an unusually strong or weak season can distort the outcome” (treadstonelaw). A business whose cash conversion cycle has been quietly lengthening will need a correspondingly larger peg to keep operating at the same revenue level after closing, whatever the headline purchase price implies about the deal’s overall size.
Each of the three pieces has a standard formula, and none of them needs anything a buyer has not already pulled together for the receivables and payables review. Days receivable outstanding is average accounts receivable divided by revenue, multiplied by the number of days in the period. Days inventory outstanding is average inventory divided by cost of goods sold, multiplied by the same period length. Days payable outstanding is average accounts payable divided by cost of goods sold, multiplied by the period length. The cash conversion cycle itself is simply days receivable plus days inventory, less days payable — the two components that tie up cash, net of the one component that defers it.
Running the same formulas on two or three prior years, not just the most recent one, is what turns a single snapshot into a trend — and it is the trend, not any one year’s figure, that tells a buyer whether the business is managing its cycle consistently or whether something has been quietly deteriorating.
A cash conversion cycle measured on a single point in time, or on a period that happens to fall at a seasonal peak or trough, can look meaningfully different from the business’s normal operating pattern without anything having actually changed. This is the same distortion working capital pegs are built to guard against — a peg “based on an unusually strong or weak season can distort the outcome” (treadstonelaw, working capital adjustment), and the fix is the same in both cases: measure across a full seasonal cycle, or explicitly adjust for the season the measurement period falls in, rather than reading one quarter’s figures as though they represented the business year-round.
It is tempting to look for a published Canadian benchmark for how long a small business “typically” takes to convert a sale into cash. That figure does not exist in a usable form here — the closest-sounding published Canadian data point actually describes something different entirely: how long it takes to sell a whole business, from listing to closing, not how long an operating business takes to turn a single sale into collected cash. Those are two unrelated clocks, and reaching for the deal-timeline figure to answer an operating-cycle question would be citing the wrong thing to the right-sounding name.
To illustrate the mechanics only — the figures are a scenario, not a benchmark — a target reports $2,400,000 in annual revenue, average receivables of $320,000, average inventory of $260,000, and average payables of $180,000, all measured over a 365-day year. Days receivable outstanding is $320,000 ÷ $2,400,000 × 365, or roughly 49 days. Days inventory, against a cost of goods sold of about $1,500,000, is $260,000 ÷ $1,500,000 × 365, or roughly 63 days. Days payable outstanding is $180,000 ÷ $1,500,000 × 365, or roughly 44 days. The cash conversion cycle is 49 plus 63 less 44 — roughly 68 days between a sale being made and the cash from it being fully realized net of what suppliers are owed.
Comparing this year’s figures against two years prior, the same business shows a cycle of roughly 52 days — the lengthening is driven almost entirely by receivables aging out, not by inventory or payables changing meaningfully, which points the buyer’s next question directly at collections practice rather than anywhere else in the business. Because the business is a retailer with a pronounced fourth-quarter peak, the buyer re-runs the same calculation on a trailing twelve months ending mid-year rather than on the fourth quarter alone, to avoid reading a seasonal inventory build-up as a permanent change in the cycle.
Related: aged receivables and what they say about collections, aged payables and stretched supplier terms, the net working capital peg glossary entry.
Generally it means less cash is tied up funding the operating cycle for the same revenue, which is favourable — but an unusually short cycle can also reflect aggressive supplier-payment discipline or receivables policies that are hard to sustain, so the trend and the reasons behind it matter more than the number alone.
Directly from the target’s own aging reports and financial statements — average receivables, average inventory, average payables, revenue and cost of goods sold — no separate data source or estimate is required.
Not automatically — it more directly affects the working capital target set at closing, since a business that ties up more cash in its operating cycle needs more of that cash funded at closing to keep operating at the same level afterward.
Over a full seasonal cycle or a trailing twelve-month period rather than a single quarter, for the same reason a working capital peg should not be set on an unusually strong or weak season — a snapshot at the wrong point in the year will not represent the business’s normal operating pattern.
A short call is enough to turn the aging reports into one working capital view.
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