Valuation

Cash Conversion

The efficiency with which reported EBITDA converts into actual cash generation — the critical metric that determines whether a business's earnings translate into the financial capacity to invest, repay debt, and return value.

Shape Executive Definition

Cash conversion (also expressed as a cash conversion rate or cash conversion cycle) measures the proportion of EBITDA that becomes available cash after accounting for working capital movements, capital expenditure and other cash requirements. A business with 100% cash conversion generates $1 of cash for every $1 of EBITDA. Most businesses convert at 70–90%, with the gap driven by working capital requirements and capital expenditure. Industrial and distribution businesses frequently convert at 60–80% due to inventory and debtor dynamics.

Cash Conversion Rate

FCF ÷ EBITDA × 100%

Or: (EBITDA − Capex − Working Capital Movement) ÷ EBITDA. Industrial businesses typically convert at 65–85%, with the gap driven by working capital and capex requirements.

How each stakeholder reads it

Cash Conversion looks different depending on your role.

Cash conversion is the explanation for why your business can be profitable and cash-poor simultaneously. EBITDA is calculated before working capital movements — it tells you how much you earned, not how much you collected. If your debtors are growing faster than your revenue, your inventory is building, or your capital expenditure is high, your cash conversion will be below 100%. The businesses that understand their cash conversion can forecast their cash position accurately. Those that manage only to EBITDA are consistently surprised when the cash is not where the P&L suggests it should be.

Cash conversion is central to our investment modelling. EBITDA is the valuation entry point, but free cash flow is what funds debt repayment, bolt-on acquisitions and ultimately exit distributions. A business with 90% cash conversion is significantly more valuable operationally than one with 65% conversion at the same EBITDA level — it generates substantially more cash for the same earnings. In industrial acquisitions, improving cash conversion through working capital efficiency is frequently one of the most capital-efficient value creation programs available.

Cash conversion is what tells you whether your business is generating or consuming cash. Improving it requires attacking three levers: reducing debtor days (collecting faster), improving inventory turns (holding less stock), and optimising capex (spending on assets that generate returns, deferring those that do not). Each lever is operational — not financial. The operator who improves cash conversion without reducing revenue creates the cash that funds growth without additional equity or debt.

Cash conversion is a board-level strategic metric. Boards that manage primarily to EBITDA without reviewing cash conversion are potentially missing the most important financial story in the business. A business whose EBITDA is growing but whose cash conversion is declining is building an increasingly cash-hungry enterprise — and eventually the cash demand will constrain growth, debt service or shareholder returns. The trend in cash conversion is as important as the absolute level.

Why it matters

Cash conversion determines whether growth is self-funding or cash-consuming.

High cash conversion means the business can fund its own growth — that every dollar of EBITDA growth translates into a dollar of cash available for investment, debt repayment or distribution. Low cash conversion means growth consumes cash — that a growing business requires increasing external funding simply to finance its own working capital and capital requirements.

In a PE context, cash conversion is the link between EBITDA improvement and debt repayment. A fund that has acquired a business with significant leverage needs cash conversion to drive down the debt quantum, improving equity returns. Improving cash conversion by 15 percentage points on a $3M EBITDA business generates an additional $450K of annual cash — which compounds significantly across a five-year hold.

Operational drivers

What shapes cash conversion inside a business.

Debtor Days

The primary variable working capital lever — every day improvement in DSO on $20M revenue releases approximately $55K of cash.

Inventory Efficiency

Reducing inventory holding through better demand planning, product rationalisation and procurement discipline.

Creditor Days

Extending supplier payment terms within agreed limits — using creditors to fund working capital rather than equity.

Capital Expenditure Discipline

Distinguishing maintenance capex (unavoidable) from growth capex (discretionary) and managing the latter rigorously.

Revenue Mix

High-margin, fast-collecting revenue streams have better cash conversion profiles than low-margin, slow-collecting ones.

Common failure patterns

How cash conversion breaks down.

EBITDA growing while cash remains flat — working capital consuming the earnings growth
High debtor days in a business with strong apparent profitability — the receivables represent earnings not yet converted
Inventory build that absorbs cash without corresponding revenue growth
Capital expenditure that absorbs EBITDA without generating identifiable returns
Seasonality in working capital not managed proactively — creating predictable but unmanaged cash troughs

Semantic relationships

Buyer Interpretation

How buyers and M&A advisers read this.

See the Buyer and Board perspectives in the stakeholder tab panel above. This is how acquirers, M&A advisers and lenders interpret this term during a transaction — and how it directly affects deal structure, pricing and terms.

Common Founder Mistakes

Cash conversion gaps that surprise founders at settlement.

The failure patterns listed above describe how this term most commonly creates value problems for founders — through misunderstanding, mismanagement or mispresentation during a process. Each pattern has a correctable upstream cause.

Related Doctrine