Cash is king. Unfortunately, for many businesses that manage inventory, cash doesn’t get the attention it deserves…that is until it starts running out!
Businesses tend to focus on the P&L, at the expense (no pun intended) of the balance sheet. Particularly in the current economic environment, optimizing working capital and maintaining sufficient liquidity needs to be a strategic priority.
This is where the cash conversion cycle (CCC) comes into play. Understanding and improving your CCC can have powerful impacts on business performance, while not understanding this can be disastrous.
What is it? The CCC is quite simply the time it takes from the outlay of cash (say for the purchase of inventory) to the receipt of cash (from the sale of that inventory). The shorter the cycle the better, as more cash on hand helps generate more sales, pay down debt, or take advantage of new opportunities.
You’ll want to measure your CCC over time and compare to others in your industry, as it will look very different for a company that sells on credit (say 30-90 days) compared to companies like Amazon that sell inventory and collect payment rapidly, while paying suppliers slowly (in fact they have negative CCC!).
It’s obvious to most that when sales slow down, liquidity can become a challenge. What’s less obvious is what can happen when sales are growing. The higher your sales, the greater your working capital requirements for a given CCC. If you’re not properly projecting cash needs, then paradoxically, higher sales can land you in cash trouble.
So what can you do to improve your CCC? Ultimately, you want to convert inventory into sales faster, collect payments from customers sooner, and extend payment timing to suppliers. There are several tactics, processes and systems that can help optimize performance across these areas. Keep in mind however that not all levers are beneficial for the business. You don’t want to run out of inventory, or blindly force payment terms on customers and suppliers. Careful analysis and consideration will be needed.
What is certain however is that management needs to understand these levers and the impact on the business. The downside risk is running out of cash!
