IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Eric Moore of Accounting Solution Partners (https://www.theaspteam.com/):
What is a Good Cash Conversion Cycle?
Your Cash Conversion Cycle (CCC) is a measure of the number of days it takes your business to convert its inventory into cash flows from sales. It is an important metric to measure because the length of the CCC (sometimes called “net operating cycle” or just “cash cycle”) is the time when your cash inputs are tied up before they are converted into sales.
So, what is a good cash conversion cycle?
A Good CCC Benchmark
There is not a single “right answer” when it comes to achieving a desirable cash cycle because every business is different. What is good for one company may be bad for another. Just understand that the best CCC is a low one (and a negative CCC is ideal because that means that you are selling inventory before you need to pay for it)!
Instead of looking at the number as a standalone determinant of how your company is doing, focus on the trend. Is your CCC going up or going down? An increasing CCC can be a troubling sign because a lengthy CCC can lead to insolvency, especially among small businesses. If your CCC is rising or if it is steady but is long enough that it is hampering cash flow management efforts and stalling business growth, it is vital to work on improving your CCC.
Shortening your CCC is a key method for increasing your cash flow by improving on what you are already doing so you do not need to look externally for assistance. Accelerating cash inflows strengthens businesses from within, allowing them to meet short-term obligations and driving long-term growth.
How to Reduce CCC
Eliminate Excess Inventory
Inventory that sits for a long time before being sold prolongs the CCC, tying up cash so it is unusable to the business. Carefully analyze and change your purchase practices – find a balance between having too much inventory and not enough.
Get rid of inventory that has been sitting around far too long, even if it is at a loss. Remember, recouping something is better than nothing because no cash is being generated from unsold inventory. Once this inventory is gone, you can free up the business to sell products that move quickly, infusing cash into the business. Instead of holding onto old inventory, prioritize acquiring and selling your core products.
Improve Forecasting
Only having as much inventory as you need on hand is a great way to improve your CCC but doing so requires accurate data analysis and forecasting. Getting inventory too far in advance of your busy season or stockpiling high-demand products can backfire, tying up cash for too long before those products are sold. This is why detailed, and reliable forecasting is so important. Knowing what your audience will want and when they will want it is critical for effective cash flow management.
Align purchasing and marketing efforts to have what you need when you need it, and not a moment sooner. You do not want to run out of inventory after a costly marketing campaign launches but you also do not need the inventory sitting around for months before your big seasonal promotions will launch. Encourage teams to work together to understand what kind of return is expected from marketing efforts so you are prepared. Limit safety stock on your most popular products so that you have enough to cover a sudden uptick in demand but not so much that it ends up becoming obsolete before you can sell it.
Encourage Prompt Payments from Customers
It may sound obvious but getting customers to pay their bills quickly requires that they receive their bills quickly. After all, customers cannot pay their bills until they have received them.
Send invoices immediately – do not wait to batch them. Use automated software to get invoices out right away and follow up as the deadline approaches. Clearly convey how much is due and when. Then begin the collections process immediately when customers are late to pay.
Incentivize customers to pay quickly by:
Providing better rates for faster payments or cash discounts
Offering rewards or incentives for prepayment
Increasing rates for customers that are chronically late
Reduce Collection Float
Paying an invoice by check results in a payment delay when the check must be physically mailed and processed by the receiving company before the money can be transferred from the customer’s bank to the company’s bank. During this waiting period the customer has paid the bill, but the company cannot yet use the funds. This is known as collection float. Eliminating checks as a form of payment in favor of credit card, virtual payment, or ACH transfer can significantly reduce your CCC.
Hire the Right Personnel
Of course, knowing which methods can be used to accelerate cash inflows is only one piece of the puzzle. A well-planned financial strategy is nothing without effective execution. Ask yourself, “Do we have the right financial personnel in place to shorten our cash conversion cycle, or do we need to bring in some help?” To get the right finance or accounting professional at the helm, utilize a financial recruiting firm to bring in a controller, accounting manager, or finance manager.
If you need help with cash flow management, reach out to our experienced accounting team! We have the knowledge needed to help your company figure out which metrics to track and how to improve them to free up more cash in your business.
If you have questions relating to the content of this article, Eric Moore of Accounting Solutions Partners would welcome the opportunity to answer them. Mr. Moore can be reached at (425) 440-3770 or eric@asp-nw.com.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.