Have you ever found yourself frustrated that your cash flow wasn’t up to par, with company’s valuable dollars tied up instead of at the ready?
Strategizing for the future requires business leaders to not only know their numbers, but also know where their money is, and in what form, at all times. This way, you can chart an effective course of action.
In order to have your finger on the pulse of what — and where — your numbers are, it’s essential to understand just how long it will take for your working capital, or inventory, to become liquid cash once more (and vice versa). This concept is called the Cash Conversion Cycle.
What is the Cash Conversion Cycle?
The Cash Conversion Cycle is officially defined as the time required to convert inventory production-related cash into accounts receivable.
This is calculated by subtracting the average age of inventory, in days, plus the average age of accounts receivable (AR) in days, minus the average age in days of accounts payable (AP).
Why measure the Cash Conversion Cycle?
The Cash Conversion Cycle is a critical metric to understand for many reasons. Firstly, it shines a light on the efficiency (or inefficiency) of a company’s sales process.
With that, the Cash Conversion Cycle can shine a light on the productivity of the sales team. If there is a longer Cash Conversion Cycle, this might mean that something is awry in terms of how sales are being conducted, and may warrant some changes to the sales methods and/or processes being utilized.
The Cash Conversion Cycle can also draw attention to your billing team. Perhaps it is not an issue of sales technique, and more of an issue with accounts receivable collection itself. How efficiently is your team at sending out invoices and/or collecting payments? If this hasn’t been addressed, it might be something to consider.
Finally, the Cash Conversion Cycle can help you identify core issues related to inventory turn. Perhaps billing and sales are up to speed, but the time it takes for inventory production to catch up to the rate of sales. The Cash Conversion Cycle can also identify these gaps, bringing awareness that can help inspire strategic shifts.
Understanding the Cash Conversion Cycle has a range of additional benefits, with one of the most notable being its ability to measure liquidity. Using the Cash Conversion Cycle, a company can use the data to identify just how quickly its assets can be transformed into cash.
Cash Conversion Cycles for Growth
Like anything, the key with the Cash Conversion Cycle is to utilize it to drive necessary changes to ensure your business is reaching its maximum potential moving forward.
While every business has different measures of success, the Cash Conversion Cycle has the potential to bring awareness to blindspots when it comes to countless internal processes, including how you manage sales, collections, and inventory, among others.
By recording your Cash Conversion Cycle today, you will have a baseline from which to measure future numbers against. If you are unsure of where to begin when it comes to improving your cash conversion timeline, try experimenting with different tweaks and continue to measure your new results against the baseline.
Cash flow management can be a complex topic for many business leaders, and may warrant a strategic financial partner to help you understand what is truly beneath the surface of your company’s current situation. If you are unsure of where to start, our team at Blueprint CFO can help you understand where you stand, and how a fractional CFO can help uncover what is possible.
Stressed about your cash flow? Contact us today. Our team at Blueprint CFO will help you understand where you are, and where you can go!