Cash conversion ratio: how much of your profit turns into cash

Short answer: the cash conversion ratio tells you how much of your profit actually arrived in the bank. The simplest version is cash from trading ÷ net profit × 100, where cash from trading is net profit, plus depreciation, minus any increase in what customers owe and in stock, plus any increase in what you owe suppliers. A business that made $120,000 of profit and $94,000 of cash from trading has a cash conversion of 78%: $26,000 of the profit is sitting somewhere other than the bank, usually in unpaid invoices or on the shelves. Over a full year, a steady business usually converts close to 100% or more, because depreciation is a cost that uses no cash. A ratio that is falling, or stays well below 100% for a year or more, is the earliest sign that profit and cash are drifting apart, and the worked example below shows how to find out why.

The cash conversion formula, and its three versions

You will see the ratio written several ways. They answer slightly different questions, so compare like with like and use the same version every time.

Version	Formula	Use it when
Owner’s version (before tax)	Cash from trading before tax ÷ net profit before tax	You read Xero, whose Net Profit is usually before company tax. A big tax payment does not distort it.
Textbook version	Operating cash flow (after tax paid) ÷ net profit after tax	You compare with published accounts or a finance article
EBITDA version	Cash from trading before interest and tax ÷ EBITDA	A lender or buyer asks how much of your EBITDA is real cash
Free cash flow conversion	Free cash flow ÷ net profit after tax	You want to know what was left after buying equipment, for the owners or the bank

Cash from trading (also called cash generated from operations) = net profit + depreciation and amortisation − increase in debtors − increase in stock and work in progress + increase in creditors. Take tax paid off it to get operating cash flow, and take money spent on equipment and vehicles off that to get free cash flow. Cash flow from operations explains each line, with three businesses that made the same profit and very different cash.

A worked example: a joinery company in Christchurch

These figures are made up. Aroha owns a joinery company that makes kitchens and fitted furniture for builders and homeowners. Its year ends on 31 March. Every figure is in NZ dollars without GST.

	Year to March 2025 ($)	Year to March 2026 ($)
Sales	960,000	1,050,000
Net profit before tax (Xero’s Net Profit)	110,000	120,000
Add back depreciation	16,000	18,000
Increase in debtors (customers owe more)	(8,000)	(36,000)
Increase in stock and work in progress	(2,000)	(14,000)
Increase in creditors (Aroha owes suppliers more)	3,000	6,000
Cash from trading before tax	119,000	94,000
Cash conversion	108%	78%

Brackets are minus figures. 2026: 94,000 ÷ 120,000 × 100 = 78%. Profit went up by $10,000, so the Profit and Loss says it was a better year. The cash says otherwise: trading brought in $25,000 less than the year before.

Why did it fall 30 points?

Most of the answer is in one line. Customers owed $126,000 at the end of March 2026, up from $90,000 a year earlier. That $36,000 increase is 30% of the year’s profit on its own.

• Debtor days went from about 34 to about 44. Last year: 90,000 ÷ 960,000 × 365 = 34 days. This year: 126,000 ÷ 1,050,000 × 365 = 44 days. Two builders started paying at 60 days instead of 30, and a large fit-out was invoiced in the last week of March.
• If customers paid as fast as last year, debtors would be about $98,400 (34 days of this year’s sales), releasing about $27,600. Cash conversion would be about 101%, in line with last year.
• Stock and work in progress rose $14,000, almost all of it timber and fittings for a kitchen that was half built at year end. That is timing, and it comes back when the job is invoiced and paid.

So Aroha’s fix is not to sell more or cut costs. It is to chase the two slow builders and agree payment stages on large jobs. The free debtor days calculator does the debtor sum on your own figures, and who owes me money? shows how to find the invoices behind it in Xero.

The other versions for the same year

• Textbook version. Aroha paid $30,800 of provisional tax in the year, so operating cash flow was 94,000 − 30,800 = $63,200. Net profit after tax at New Zealand’s 28% company rate is 120,000 × 0.72 = $86,400. 63,200 ÷ 86,400 = 73%. It is lower than the owner’s version because tax is paid on a different timetable from the year’s profit.
• EBITDA version. The company paid $5,000 of loan interest, so EBITDA was 120,000 + 5,000 + 18,000 = $143,000, and cash from trading before interest and tax was 94,000 + 5,000 = $99,000. 99,000 ÷ 143,000 = 69%. This is the figure a lender is most likely to look at, and 69% would prompt questions.
• Free cash flow conversion. Aroha also bought a CNC router for $45,000. Free cash flow was 63,200 − 45,000 = $18,200, and 18,200 ÷ 86,400 = 21%. One machine purchase makes this version swing far more than the others, so use it to see what was left for the owner and the bank this year, not to judge the trend. The free cash flow calculator does it for your figures. If the business has a loan, the repayments come out of that $18,200 too: unlevered vs levered free cash flow shows what is left for the owner once the lender is paid.

What is a good cash conversion ratio?

There is no official benchmark, and figures you find online usually come from large listed companies. As a rule of thumb for a small business, using the owner’s version over a full year:

• Around 100% or above is normal for a steady business. Depreciation alone pushes it over 100% when debtors, stock and creditors hold still.
• 80% to 100% is fine for a growing business, because more sales means more invoices waiting to be paid and often more stock. The growth has to be funded, though, so check the bank balance can carry it.
• Under about 80% for a year, or falling two years running, needs an explanation. Look at debtors first, then stock, then whether suppliers are being paid faster.
• Negative means trading used cash in a year that showed a profit. Something else (the bank balance, an overdraft, the owner) paid for the business.
• Well over 120% is not always good news. It can mean the business is collecting deposits in advance, running stock down or paying suppliers late, which flatters one year and reverses in the next.

The trend matters more than the level. A business that went from 108% to 78% has a problem to find, even though 78% would be unremarkable on its own. The cash conversion cycle calculator is a different measure with a similar name: it counts how many days of cash your debtors and stock tie up, less the days suppliers give you.

How to work out your cash conversion in Xero

1. Run Accounting › Reports › Profit and Loss for the last 12 months. Note Net Profit and the depreciation expense.
2. Run the Balance Sheet at the start date and the end date (for example, 31 March last year and 31 March this year). Note Accounts Receivable, Inventory (if you track stock or work in progress) and Accounts Payable.
3. Work out cash from trading: net profit + depreciation − the increase in receivables − the increase in inventory + the increase in payables. A decrease works the other way round.
4. Divide by net profit and multiply by 100.

Xero’s receivables and payables include GST or VAT, so the changes come out slightly bigger than the sales and costs behind them. That does not matter for a trend, as long as you do it the same way every year. For the textbook version, the total of the Operating Activities section in Xero’s Statement of Cash Flows is your operating cash flow after tax paid; Xero Statement of Cash Flows covers the checks to make before trusting it. Menu names move between Xero releases and regions, so search Xero Central for the report name if your screen differs.

Do it for a full year, then repeat it each quarter for the last 12 months. A single month swings too much: one large invoice raised on the 30th can make a good month look like a disaster.

Common mistakes

• Mixing versions. Operating cash flow after tax divided by profit before tax gives a lower figure than either consistent version, and it jumps in years with a large tax payment.
• Including loans or owner money. A loan paid in, or the owner putting money in, raises the bank balance but is not cash from trading. Leave financing out.
• Taking off equipment purchases in the owner’s version. Buying a van is investing, not trading. Use free cash flow conversion for that question.
• Reading one month. Use 12 months, and compare the same 12 months a year earlier.
• Ignoring a ratio over 100% in a bad year. Running stock down or paying suppliers late can lift cash conversion while the business gets weaker.

Common questions

What is the cash conversion ratio? It is the share of a business’s profit that turned into cash over a period. Divide cash from trading (net profit, plus depreciation, less any increase in debtors and stock, plus any increase in creditors) by net profit and multiply by 100. A ratio of 78% means 78 of every 100 of profit reached the bank.

How do you calculate cash conversion? Take net profit for the year, add back depreciation, take off the increase in money owed by customers and in stock, add the increase in money owed to suppliers, then divide the result by net profit. With 120,000 of profit and 94,000 of cash from trading, cash conversion is 78%.

What is a good cash conversion ratio? For a small business over a full year, around 100% or more is normal when it is steady, and 80% to 100% is common when it is growing. Below about 80% for a year, or a ratio that keeps falling, is worth investigating. Debtors are the usual cause, then stock.

What is free cash flow conversion? Free cash flow divided by net profit after tax. Free cash flow is operating cash flow less money spent on equipment, vehicles and other long-term assets, so it shows what was left for the owners and lenders. One large purchase can swing it a long way, so judge the trend with the operating version.

What is cash conversion of EBITDA? Cash from trading before interest and tax divided by EBITDA. Lenders and buyers use it to check how much of a business’s EBITDA turns into cash. It is lower than EBITDA whenever customers owe more or stock has grown over the period.

Is the cash conversion ratio the same as the cash conversion cycle? No. The ratio compares cash with profit as a percentage. The cash conversion cycle counts days: debtor days plus stock days minus creditor days, which is how long each dollar is tied up between paying a supplier and being paid by a customer.

Your cash and profit, side by side every Monday

ReportPilot reads your Xero figures and sends a short plain-English email every Monday. It covers sales and profit against last month and the same month last year, the cash in the bank against the end of last month, money owed to you that is past due and by whom, and bills due in the next two weeks against your cash. It asks Xero for read-only access, and there is a 14-day free trial with no card.