In the dynamic landscape of rapidly expanding businesses, the outflow of cash can be astonishing.
If your business is funded conventionally through debt loans or invoice financing, mastering the rate of growth becomes paramount.
For those managing businesses backed by investors intent on fueling substantial expansion, with profits anticipated either pre-exit or upon exit, their concerns may differ.
Yet, for the majority, striking a balance between growth and available cash remains a daily tightrope walk.
How can you amplify the efficiency of your business’s cash flow?
A multitude of businesses utilise their Cash Conversion Cycle as a strategic Key Performance Indicator (KPI).
Perhaps the term is unfamiliar? It was for me as well until our part-time Finance Director introduced me to the concept a few years ago. We pinpointed our cycle, and after the initial shock subsided, we embarked on refining the effectiveness of our cash utilisation.
Our business manufactured both standardised equipment and bespoke solution product lines. The latter, inevitably, tied-up our cash. Funds meant for replenishing components in the high-volume, standard range remained locked on the shop floor, trapped as prolonged work-in-progress.
Calculating Your Cash Conversion Cycle:
To establish your Cash Conversion Cycle, follow these three steps and collate data from the business :
Step 1: Inventory + Work-In-Progress
- Determine the days your cash is immobilized in this segment.
- Trim these days to augment available cash.
Set your timeframe (monthly, quarterly, 365 days), maintaining consistency throughout the process.
Formula for Days Inventory Outstanding (DIO):
(Average Inventory & WIP Value / Cost of Goods Sold) * Number of Days in the Period
Robust forecasting is CRUCIAL for optimal cash use in supporting inventory management. On-Time & In-Full performance data enhances forecasting precision. Whether automated or manual, meticulous data capture, monitoring, and recording are essential.
From this, pinpoint areas for process enhancement and integrate them into strategies for operational excellence. Witness cash becoming accessible for investment in higher value-added sectors.
Step 2: Accounts Receivables
- Compute the average days required for payment receipt.
- Shortening this period bolsters cashflow.
Formula for Days Sales Outstanding (DSO):
(Average Accounts Receivable / Total Credit Sales) * Number of Days in the Period
Every day you reduce payment wait time positively impacts cashflow efficiency.
- Streamline credit policies
- Timely invoicing
- Vigorous pursuit of delinquent payers
- Offer early settlement discounts (e.g., 2.5% discount for payment within 14 days)
Step 3: Accounts Payable
- Calculate the average days to settle supplier payments.
- Maximizing credit terms while nurturing supplier relationships enhances cashflow efficiency.
Formula for Days Payables Outstanding (DPO):
(Average Accounts Payable / Total Credit Purchases) * Number of Days in the Period
- Negotiate favorable terms
- Align payment terms with project milestones
- Consider exclusive supplier contracts for mutual cash and supply benefits
Calculate Your Cash Conversion Cycle
Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payables Outstanding (DPO)
Track this number weekly or monthly, initiating improvements to reduce it.
Remember, benchmarking might not apply uniformly across sectors. Diverse industries present distinct dynamics. Calculate and monitor your own metrics.
This is also a great Return On Investment (ROI) measurement tool for capex projects, including:
- Automation initiatives
- Digitization projects
- Lean strategies
- Improved maintenance regimes
- New machinery
If these ventures not only enhance efficiency but also bolster profits, customer retention, and growth, it’s a resounding win-win.
For further insights, visit our website at www.cloud-busting.com or connect via email or LinkedIn.
