O2 for your business
Do you measure how much oxygen (read cash) is your business breathing!!
What is CCC
The typical manufacturing company’s cash conversion cycle usually looks something like this:
- Cash is paid out for equipment, raw materials, salaries, overhead, etc.
- These outlays are used to manufacture products.
- The products may then be stored in a warehouse until sold to customers.
- After products are sold, the business issues an invoice to customers, creating accounts receivable. 5. Accounts receivable are collected from customers, which brings cash back in again.
The total number of days from the beginning of step number one until the end of step number five represents the length of your cash conversion cycle ie. your CCC days.
The challenge is to reduce CCC days and the resulting cash flow deficit. Or in other words, the goal is to convert the cash used in the inputs (raw materials, inventory, wages, rent, utilities, etc.) required to manufacture and distribute products into collected receivables more quickly & reduce your dependence on high cost external borrowings, which directly impacts your profitability.
How to do it:
1. Reduce your receivables: Tighten your payments terms with your customers, faster you collect your receivables shorter are your CCC days. Most of the businesses, have to offer credit payment terms of some type to their customers (e.g., if it is 45 days). In this scenario, to reduce your CCC days, you may negotiate with customers to try to shorten these terms, if possible.
One strategy is to offer a cash discount for paying early. For example, if you offer 1% cash discount for upfront payment & your borrowing cost is 12%, then even after paying 1% discount to your customer it will shorten your CCC days & improves your profitability directly by 4%.
2. Maintain your payable terms:If you receive no benefit from paying early, you should always pay invoices according to the terms you’ve negotiated with your suppliers. Work closely with your accounting department to set up a payables management system in which all invoices are paid as close to the due dates as possible.
3. Optimize your inventory levels: By implementing just-in-time (or JIT) inventory management, your raw materials will be delivered as they’re needed, not weeks (or even months) early. Also, don’t hesitate to cut your losses on slow-moving inventory items, even if this means selling them at a big discount. Doing so will free up valuable cash that can help carry you through the cash conversion cycle.
4. Accelerate Collection Process: Try to best utilize treasury management services from your bank. Talk to your bank about treasury management products and services that can help accelerate the collection and posting of your accounts receivable and reduce idle funds lying in your non functional bank accounts. These may include using sweep account, remote deposit capture (RDC), and electronic payments via the Automated Clearing House (ACH) etc.
Concluding Thoughts
Regardless of how strong your company’s sales and revenue are, it takes cash to keep your business going. One of the best ways to boost cash flow is to improve management of your cash conversion cycle. It’s important to calculate your cash conversion cycle to determine if you will have enough liquid capital to keep operations running, and to manage your cycle in order to reduce your need for external borrowing or raising more equity capital and increase your profitability.
CFO Ladder as an outsourced CFO services provider can help you make this calculation and take steps to reduce your cash conversion cycle and cash flow lag.
Feel free to reach out to me at amitbhuttan@cfoladder.com
