Working capital optimisation: Reduce DSO, improve cash conversion cycle

Published 6 March 2026

Table of contents

• What is working capital management?
• How the cash conversion cycle works
• Reduce your DSO to get paid faster
• Tips to improve the cash conversion cycle
• The best cash-flow metrics to track each month
• Manage your working capital with Xero
• FAQs on working capital management

Key takeaways

• Working capital management is the practice of managing your cash flow and the stock you hold (your current assets).
• Keep a close eye on receivables, payables, and stock to ensure your business always has enough cash to operate smoothly.
• Send invoices promptly, offer online payments, automate reminders, request deposits, and set clear credit limits to get paid faster.
• Balance stock levels, streamline work in progress (WIP), and plan supplier payments so cash moves through your business efficiently.
• Track how long stock sits, how quickly customers pay, and how long you take to pay suppliers, and review overdue invoices and bills weekly to spot trends and avoid cash flow surprises.

What is working capital management?

Working capital management is how you manage the cash coming into your business and going out (your cash flow), and the stock you hold (your current assets). It helps you keep enough money on hand to pay bills and operate smoothly. Working capital is what’s left after you subtract your short-term debts from your short-term assets.

When you manage this well, your cash flow is more predictable and you spend less time chasing late payments or worrying about slow periods. This helps retail, trades, and service businesses that deal with late payers or seasonal ups and downs.

Once you understand your overall working capital, you can measure it in more detail using the cash conversion cycle – a formula that helps you see how quickly cash moves through your business.

Here’s more on cash flow from the ATO.

How the cash conversion cycle works

The cash conversion cycle (CCC) measures how long it takes to turn your spending back into cash. It tracks three stages of your working capital:

• DIO (days inventory outstanding): how long stock sits before it’s sold
• DSO (days sales outstanding): how long customers take to pay you
• DPO (days payables outstanding): how long you take to pay suppliers

The formula for calculating cash conversion cycle is:

DIO + DSO – DPO = CCC

A shorter CCC means cash flows back into your bank account faster, which gives you more flexibility and reduces the need for short-term borrowing. The goal is to sell stock quickly, collect payments promptly, and pay suppliers at sensible intervals.

Of these stages in the cash conversion cycle, the time it takes customers to pay – the DSO metric – is often the biggest opportunity to improve your cash flow.

Reduce your DSO to get paid faster

Reducing DSO means reducing the time your money is tied up in unpaid invoices. This means getting paid faster, which improves cash flow.

Reduce your DSO by making payments easier for customers and clearer for your team.

1. Send invoices on time with clear terms

Many late payments start with late invoicing. Send invoices straight after delivery or completion. Keep the payment terms simple – for example: 'Payment due in 7 days' or 'Payable on receipt'.

On your invoice, include what you delivered, the total amount due, and clear instructions on how to pay.

2. Offer online payments and multiple options

Customers pay faster when the process is easy. You can send online payment buttons or links to a customer by email, SMS, or invoice that lets them pay instantly with a credit card or bank transfer.

Offer card payments, bank transfer, PayPal, or direct debit so customers can choose what works best and pay in fewer steps.

3. Automate reminders and collections

Automated reminders keep your invoice at the top of the customer’s inbox without your team spending hours chasing payments. It also ensures a consistent process and reduces awkward conversations.

In your message headers, use friendly wording and escalate your tone over time. For example:

• pre-due reminder
• 3 days overdue
• 7 days overdue
• final notice

4. Request deposits and use progress invoices

For large jobs or long projects, ask for a deposit in advance. You can also issue progress invoices at agreed intervals to help you collect cash as you complete the work. This way, you’re not waiting months to be paid in full.

5. Use early‑payment discounts and late fees as incentives

A small discount for early payment can motivate customers to settle their invoices quickly.

You could also think about late fees to help set customer expectations and reduce late payments. But make sure you lay these out clearly in your terms of service so there are no surprises.

6. Set credit checks and customer limits

Before extending payment terms to new customers (giving them longer to pay), or considering invoice financing, you can seek assurance in their ability to pay you by:

• running a credit check (with the customer’s permission) through agencies to see payment history, defaults and financial risk
• asking for two or three trade references to confirm whether the customer pays on time and has a good record with other suppliers
• requesting financial statements such as profit-and-loss, balance sheets, or cash flow reports from larger customers
• using credit-scoring tools in your accounting or accounts receivable software to rank your customers, flag risks, and track late-payments

You can also set credit limits so no single customer can build up unpaid amounts that put your cash flow at risk.

7. Prioritise disputes and reduce rework

Delayed payments can often come from errors on the invoice or disagreements about the work. Set out a clear internal process within your business to review disputes quickly.

Fixing mistakes early reduces rework, speeds up payment, and protects your customer relationships.

Tips to improve the cash conversion cycle

Improving your CCC means balancing stock, managing supplier payments, and planning cash movements. These actions help reduce the time between spending money and getting it back.

Cut excess stock and improve turnover

Stock that sits too long ties up cash. Review slow-moving or outdated items and adjust your purchasing to focus on in-demand, high turnover products and services.

Use stock forecasting tools to order based on real demand, not guesswork.

Negotiate supplier terms and extend DPO

Longer payment terms give you more breathing room. If you have a strong relationship or steady order volumes with your suppliers, they may offer 30–45 day terms.

Only extend terms if it doesn’t damage relationships or cause supply issues.

Streamline your fulfilment processes and reduce work in progress (WIP)

WIP refers to jobs or projects that have started but aren’t finished yet. In trades and services, long WIP delays mean you can’t invoice – and if you can’t invoice, you can’t collect cash.

Look for bottlenecks such as scheduling delays, waiting on approvals, or slow handovers. Even small improvements can shorten your CCC by reducing the time between completing a job and receiving payment.

Here’s more information on improving your operational processes and workflow.

Use cash flow forecasts to time purchases

A simple forecast helps you time stock orders, plan large purchases, and avoid cash gaps.

Forecasts don’t need to be complex. The goal is to understand when cash comes in and when big outflows occur so you can make better decisions.

The best cash-flow metrics to track each month

You won’t know how well your cash is moving unless you measure it.

Tracking a few key numbers each month gives you early warning when cash flow is tightening or when customer behaviour changes.

Track your DSO, DIO, DPO, and CCC

Tracking a few simple cash-flow metrics each month helps you understand what’s changing in your business before issues build up.

Monitor these monthly to spot trends early:

• rising DSO means customers are taking longer to pay
• increasing DIO suggests stock isn’t selling quickly
• falling DPO could mean you’re paying suppliers too early
• CCC gives a clear view of overall cash efficiency

Check your aged AR and AP each week

Aged accounts receivable (AR) and accounts payable (AP) reports give you a breakdown of overdue customer invoices and upcoming supplier bills so you can stay on top of cash movement.

Your aged AR report shows which invoices are overdue, and aged AP report shows which bills are due soon.

Check these weekly to help avoid surprises and prompt timely conversations with customers and suppliers.

Set thresholds and alert rules

Create simple internal rules to help teams act early and consistently. For example, you could:

• follow up any invoice more than 3 days overdue
• flag customers who exceed their credit limit
• review stock items stuck for more than 60 days

Manage your working capital with Xero

Xero makes it easier to manage your working capital. Xero speeds up your invoicing, payments and reporting by automating your manual processes, and makes it simpler to track your cash flow.

With Xero you can:

• send invoices quickly and add online payment links
• automate reminder emails and track overdue invoices
• sync bills, schedule payments, and manage supplier terms cleanly
• use apps for stock management, cash flow forecasting, and job progress tracking

Together, these tools shorten your DSO, keep the cash conversion cycle tight, and give you a clear view of your working capital each month.

Get one month free

FAQs on working capital management

Here are answers to common questions from business owners in retail, trades, and services when calculating and managing working capital.

What is a good DSO?

A 'good' DSO (days sales outstanding) metric depends on your industry and payment terms. As a guide, your DSO should be close to your agreed payment terms.

For example, if you offer 14-day terms but your DSO is 35 days, there’s room for improvement.

Is negative working capital bad?

Negative working capital means you owe more in the short term than you have available right now. It’s not always bad – some retailers and trades businesses run this way because they get paid before bills are due.

But if cash is tight or unpredictable, negative working capital can become risky.

How often should I review CCC?

Check your CCC (cash conversion cycle) monthly, or weekly if cash flow is tight. Regular reviews help you spot issues early, such as rising stock levels or slower customer payments.

How can I improve working capital without changing terms?

If you can’t change payment terms, focus on your operations and internal processes. For example, you might need to invoice faster, reduce billing or stock errors, improve stock turnover, speed up job completion, and send timely payment reminders.

Small changes in these areas can often be just as effective as adjusting your payment terms.