Increase the velocity of cash in your business.

One of the most important metrics that a business owner should understand is the cash conversion cycle (CCC) of their business.  The cash conversion cycle measures the amount of time, in days, between the investment of resources in a business, when you pay for those resources and ultimately when you are paid by the customer for the value that they received from those resources.  Resources can be human capital, such as programmers or consultants, or inventory offered for sale.  The cash conversion cycle is a measure of the velocity of cash through your business.

Understanding the details of your cash conversion cycle allows you to effectively plan for the amount of working capital your business will require as it grows.  Understanding those same details will allow you to focus on finding creative ways to improve the velocity of cash through your business by reducing working capital.  Reduced working capital generally means reduced borrowing, reduced risk and higher returns to shareholders.  The lowest cost form of funding for your business is often the cash that can be freed up by improving working capital performance and profitability.

How do you measure your cash conversion cycle?

Your cash conversion cycle is expressed in days and is measured in 3 separate parts – inventory, accounts receivable and accounts payable.   

Average Days of Inventory – This represents the average number of days of inventory stock that your business maintains before it is sold to and accepted by a customer. 

Inventory can consist of raw materials, materials in product and finished product as well as items that are in transit to you from a supplier.  Finished product includes those items that are in your own warehouse or items that you may have consigned to a customer. 

AVERAGE DAYS OF INVENTORY (DOI) = INVENTORY $ / (COST OF GOODS SOLD $ / 365)

 Average Days of Payables – This represents the average number of days between when the company purchases or consumes labor, services or inventory and when they have to pay for them.

 AVERAGE DAYS OF PAYABLES (DOP) = ACCOUNTS PAYABLE $ / (COST OF GOODS SOLD $ / 365)

Average Days of Sales Outstanding – This represents that average number of days between when goods or services are sold to your customer and when you receive cash.  To accurately calculate this metric, it is important to consider both accounts receivable that has been billed to your customers and amounts that have been earned but not yet billed.  If your business bills every day or two, then this distinction doesn’t have a significant impact on cash flow or the measurement of cash conversion cycle.  If your business bills every two weeks or even monthly, this lag time between when product or services are provided and when it is billed and ultimately collected can have a significant impact on your cash conversion cycle. 

 AVERAGE DAYS SALES OUTSTANDING (DSO) = ( ACCOUNTS RECEIVABLE $ / (SALES $ / 365) ) + AVERAGE DAYS OF UNBILLED RECEIVABLES

 Cash conversion cycle is the Average Days of Inventory LESS the Average Days of Payables PLUS the Average Days Sales Outstanding.

CCC = DOI – DOP + DSO

 How do you improve your cash conversion cycle?

Cash conversion cycle can be measured on an overall basis by performing the calculation on amounts from your financial statements.  This is valuable in determining the total working capital your business will need as it grows, and it is helpful in monitoring trends and understanding the velocity of cash through your business.  It is also useful in modeling the amount that you can increase your cash balance by improving working capital performance.

For example, consider a company with:

  • $10 million in revenue selling at 40% margins
  • 25 days of inventory in-transit,
  • 20 days of inventory on-hand,
  • 20 days of inventory consigned at their customers, that
  • bills their customers 5 days after month end, that
  • pays their vendors on average in 25 days

Next, consider what improvements to their cash position could be made by:

  • Billing customers within 3 days of the 15th and last day of each month, a $233K improvement
  • Eliminating the consigned inventory program with their customer,  $329K improvement
  • Negotiating with their supplier to accept title for product when received rather than shipped, a $411K improvement
  • Paying suppliers on average in 30 days, a $82K improvement
  • Implementing a supplier managed inventory program with their vendors, reducing their average inventories to 5 days, a  $247K improvement

Cash conversion cycle doesn’t have to be a top-level financial measurement.  You can make the measurement more actionable by calculating elements of the cash conversion cycle for each of your customers, individual sales contracts, and individual products and for each of your vendors.  You can improve your cash conversion cycle by billing more frequently, accepting retainers and deposits, focusing on past due accounts, negotiating better terms with your suppliers, creating drop-ship programs with customers and vendors and reducing inventories.  Remember, cash conversion cycle is a measurement of cash velocity and increased velocity reduces borrowing, reduces risk and improves return to shareholders.

My mission is to help business owners succeed by taking the guess work out of improving profits, increasing cash flow and driving business value. 

What difference would it make to your business if you could?

•      Trust your financial forecasts and understand your cash

position?

•      Rely on your financial statements and be sure that your accounting is accurate?

•      Find cash from within your business to invest and grow by improving your cash conversion cycle?

•      Understand the financial and cash impact of an investment, a decision or other significant event on your business?

•      Have more time to focus on your customers and products and to lead your business? 

•      Stop ending every month in a panic?

I am passionate about working with owners who are committed to increasing the value of their business.  Many of these owners are tired of financial processes that don’t accurately report on the past or predict future cash flows and that are challenged in bringing value to managing business performance and decision making.  They’re frustrated by surprises, a lack of actionable information, inconsistency and not understanding results.  Most importantly, these business owners will actually do something about these problems.  They want to make the right decisions to grow their business, to improve operational performance, to increase cash flows and to build a stable financial platform on which to grow the business – all of which drives business value.

Do you need help in implementing financial processes that will increase the value of your business and improve operational performance?  Would you like to improve the velocity of cash in your business?  If you would like to learn more about my services, please send me an e-mail or call me at 480-433-1310.

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