Your cash conversion cycle is the key to unlocking strength and growth in your business without taking on debt or other restrictive finance facilities. By effectively managing your cash conversion cycle, finance would never be the bottleneck in your business. Imagine running a business where you are paid for your products or services before you pay your suppliers – every dollar input into your business produces a return before having to pay expenses – your profits can be re-invested immediately for more profits, resulting in compounding returns. This is unachievable when your cash conversion cycle is working against you. Debt based finance facilities (such as loans and overdrafts) do not fix the problem – they hide the issue until your business hits a new growth limit, at which point your cash conversion cycle is again working against you. The key to long term sustainable business success and growth is to fix your cash conversion cycle as your first priority.
So, what is the cash conversion cycle? Let me answer that with another question – how long does it take your business to convert every dollar you put in, into profit you receive? The number of days it takes for you to turn an investment into a return is called your cash conversion cycle – the longer your cycle the more cash you need to run your business and the more your business is at risk of suffering from cash flow problems. Understanding and managing your cash conversion cycle is critical to your success, and fortunately there are actions you can take to manage your cycle. By managing your cycle effectively, you can optimise your business so that it runs efficiently – an efficient business makes profits quicker, without taking on any extra debt.
To understand the cash conversion cycle, let’s begin by looking at how the figure is calculated. The formula takes into account how long it takes for a business to sell its inventory plus how long it takes to receive payment for sales, minus how long the business has to pay its creditors. The formula is:
CCC = inventory sell time + payment receipt time – creditor payment time.
Note that “inventory” doesn’t strictly imply warehoused goods – “inventory” may be work in progress (WIP) such as in the construction or manufacturing or haulage industries where the “inventory” is being built, manufactured or moved.
The higher the cash conversion cycle, the longer it takes to realise a profit. The longer it takes to realise a profit, the more cash you need to run your business compared to a competitor with a lower cash conversion cycle who realises their profits quickly. With a high cash conversion cycle, the size of your business and the amount of profit you can make will be limited by the amount of funds you have available to invest in your business. When there is opportunity to grow a business but it’s limited by the availability of funds, some business owners will simply look for “more cash”, often using long-term wealth assets (such as property) for short term business finance such as overdrafts or loans. They will forgo building their long term “secure” wealth so that they can grow their business to the next size limit. Other’s will choose a better path – before pouring funds into a business, they will improve their cash conversion cycle so that they can achieve growth without sacrificing assets – they will look for efficiency first.
So how can the cash conversion cycle be managed? It depends on each business and the industry in which they operate. Let’s look at each part of the equation:
- How long it takes to sell stock. The longer it takes to turn over stock, the longer your cash conversion cycle is. If you can sell stock faster without sacrificing much profitability (for example through small pricing adjustments or offering incentives), then your cash conversion cycle will decrease. Making slightly smaller profits more frequently will result in more total profits over time. The goal is to sell stock as quickly as possible without sacrificing too much profit.
2. How long it takes to receive profits. The sooner you receive payment for your goods or services, the sooner you can put those earnings back into your business to produce more product and profit. If you could halve the time it takes to receive income then theoretically your business could grow in proportion to the size of your accounts receivables. Getting paid sooner could be achieved through actions such as better customer selection (i.e. only supplying those customers that pay quickly and pay on time), offering early payment discounts to your customers, or utilising a debtor finance facility. Of these three examples, only the debtor finance facility will give you complete control over when you get paid, and in nearly all cases the cost of debtor finance is far less than the cost of offering discounts. The goal is to get paid as soon as possible.
3. How long you have to pay your creditors. The longer you have to pay your creditors, the longer your funds are working in your business, making more profits for you. If you could double the time you have to pay your creditors, then theoretically your business could grow in proportion to the size of your accounts payables. Extending creditor payments can be difficult – your creditors want to get paid as soon as possible – but never-the-less it can be achieved. Utilising a Supplier Finance facility allows you to effectively extend creditor payments without impacting your creditors. The cost of supplier finance facilities is often far less than the increased profit you can make by having your funds working in your business instead of paying your creditors. The goal is to pay your creditors as late as possible without going overdue.
By using a combination of strategies to accelerate sales of stock, receive your profits sooner and delay payments to your suppliers, your cash conversion cycle will be reduced and you will find that you will have funds available to grow your business without taking on debt. The aim is to minimise your cash conversion cycle or, if possible, achieve negative days, meaning that you get paid before you pay your suppliers – if you can achieve this you will never have a cash flow problem again! Financing facilities such as debtor finance and supplier finance are tools designed to help you minimise your cash conversion cycle so that your business runs efficiently, maximising profits at minimal cost. When your cash conversion cycle is minimised, every dollar you invest in your business will produce maximum profits and your business can really grow. If you can achieve a negative cash conversion cycle then there’s no working capital limit to the size of your business. Our financing facilities are designed to help you achieve a negative cash conversion cycle – something that secured lending facilities can’t ever achieve.