Free Cash Flow (FCF) conversion is one of the most important measures of a company’s financial health. While revenue growth and profitability often grab the headlines, free cash flow is what ultimately funds expansion, pays down debt, and returns value to shareholders.
Many CFOs and investors track not just the level of free cash flow but also free cash flow conversion — the percentage of accounting earnings that actually translate into cash.
In this article we will explain what FCF conversion is, how to measure it, why working capital is usually the biggest reason for weak conversion, and why accounts receivable management and DSO play a central role.
What is free cash flow conversion?
Free cash flow conversion measures how much of a company’s reported earnings (often EBITDA or net income) actually turns into free cash flow.
A high FCF conversion means earnings are efficiently being converted into cash.
A low FCF conversion means profits look good on paper but cash is not materializing.
Investors, lenders, and CFOs look closely at FCF conversion to judge the quality of earnings and the company’s ability to fund itself without external financing.
How to measure free cash flow conversion
The formula for free cash flow conversion is straightforward:
FCF Conversion = Free Cash Flow ÷ EBITDA (or Net Income)
Where:
Free Cash Flow (FCF) = Operating Cash Flow – Capital Expenditures
EBITDA = Earnings before interest, tax, depreciation, and amortization
Some companies use net income instead of EBITDA as the denominator. What matters most is tracking the trend over time and benchmarking against peers.
Example of FCF conversion
Imagine a company reports the following for the year:
EBITDA: $50 million
Operating Cash Flow: $30 million
Capital Expenditures: $5 million
Step 1: Free Cash Flow = $30m – $5m = $25m
Step 2: FCF Conversion = $25m ÷ $50m = 50%
This means that only half of reported EBITDA actually converted into free cash flow.
Why FCF conversion breaks down
The most common reason for poor FCF conversion is working capital. Even profitable businesses can struggle to generate cash if too much of it is tied up in receivables, inventory, or payables.
Among these factors, accounts receivable is often the biggest driver.
If customers take longer to pay, accounts receivable grows.
As receivables grow, cash is locked up instead of flowing into the bank account.
This is directly reflected in weak free cash flow conversion.
In other words, strong revenue growth combined with weak collections can make a business look healthy in P&L terms but cash-starved in reality.
The role of DSO in FCF conversion
Days Sales Outstanding (DSO) is the key metric linking accounts receivable to free cash flow.
Higher DSO = slower collections = lower free cash flow conversion.
Lower DSO = faster collections = higher free cash flow conversion.
Even small changes in DSO can have a huge effect. A $100m revenue business with 30 extra days of DSO could have more than $8m in additional cash tied up in receivables, directly reducing free cash flow. If the company has an 8% EBITDA margin, this would cut the actual Free Cash Flow in half.
This is why many CFOs look at both DSO and FCF conversion together. If DSO is rising, FCF conversion is almost always falling.
How to improve FCF conversion through AR management
To strengthen free cash flow conversion, companies must get working capital under control. On the receivables side, that means:
Invoice on time and accurately
Prevent disputes and avoid giving customers excuses to delay payment.
Track and manage DSO
Measure DSO monthly and investigate spikes immediately.
Automate collections
Use AR automation to send personalized reminders before and after due dates.
Resolve overdue customers within the first 30 days
Set up clear escalation processes so billing issues do not drag on for weeks.
Final Thoughts
Free cash flow conversion is a vital measure of financial strength because it shows how much of your reported earnings actually makes it into the bank. The biggest drag on FCF conversion is usually working capital, and within that, slow-paying customers.
By managing accounts receivable tightly and reducing DSO, companies can unlock significant amounts of cash and transform weak FCF conversion into strong performance.
Want to see how AI can improve your free cash flow conversion by reducing DSO? Book a demo with our team.