In my last blog on 3 Ways of Improving Days Sales Outstanding, I shared thoughts and insight
on one of the newer metrics of financial management that many organizations are focusing on. I was fascinated by the response and had several great conversations about it and how the information was helpful in terms of immediate application to the decision-making required to improve the DSO.
One of the conversations I had with a former business acumen workshop participant who is a Supply Chain leader led to an interesting dialogue on another related topic called the Cash Conversion Cycle (CCC) and this blog will share some interesting content on that emerging concept as well.
What is the Cash Conversion Cycle?
The cash conversion cycle (CCC) is a financial management metric that presents the time (typically measured in days) it takes for a company to convert its inventory and other marketable assets into cash. For example, in one of our pharmaceutical industry business simulations when the new leadership team takes over the company is a mess. They have over $1 billion of inventory and since they have been marketing and selling so poorly their cash conversion cycle is over 370 days! By implementing a transformative digital marketing strategy, teams in the simulation are able to generate demand, drive sales, and reduce inventories. One team was able to get their CCC to 95 days within two simulated years.
Just as an FYI, another name for the Cash Conversion Cycle is the “Net Operating Cycle” in case you don’t find it on your company’s financial metrics dashboard. In addition, this metric also considers how much time the company needs to sell its inventory, how much time it takes to collect receivables, and how much time it has to pay its bills.
From an Operational Efficiencies perspective, the CCC is one of several quantitative measures that helps evaluate the efficiency of a company's operations and management. A trend of decreasing or steady CCC values over multiple periods is a good sign while rising ones should lead to more analysis and concern about the future of the business. Remember, profit is not cash. Cash is cash and if the cash is not collected or is tied up in inventories and or receivables investments can’t be made in other parts of the business.
Why is it important?
The cash conversion cycle is a good indicator of the overall financial health of a business. As I like to say in my business acumen sessions, “Like blood that flows through our bodies to keep us alive, cash is the lifeblood of a business that keeps the business alive.”
If cash is pumping through the business at a good rate and being collected faster than it is going out, the business will have positive net cash flows which is one of the primary drivers of how much a business is valued for (market capitalization). It also means it can pay its employees and invest in the future of the business in functions like R&D, Sales, Marketing, and Customer Service.
What can a business do to accelerate cash conversions?
There are several key “levers” that a business can focus on to increase the cash conversion rate. I will list them below and provide some color commentary on which function drives the levers of the CCC so you can start to think about ways your department may be able to help:
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Keep inventories at reasonable levels through strong Sales and Marketing efforts that drive demand but don’t run out of stock. |
Manufacturing who makes the products and Marketing and Sales who creates and forecasts demand. |
As a general benchmark, most companies keep 2-3 months of inventory as safety stock. |
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Collect all Account’s Receivables on or before they are due. One idea is to incentivize customers to pay early with a small discount. |
Accounting and Sales. |
A general benchmark is offering your customers a 1% discount on their bill if they pay within 30 days. |
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Make sure invoices are clean, clear, and error-free. If there is a mistake on an invoice that is an invitation to lengthen the CCC. |
Accounting and Sales. |
Many companies implement Lean Thinking best practices to create error-free billings. |
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Make sure you have a Purchase Order. It’s one thing to send an invoice, another to have a PO to make sure you will be paid. |
Accounting and Sales. |
Most companies will not ship products or deliver services without a PO. |
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Manage the Supply Chain and delivery of products to customers the best you can. Disruptions in the supply chain means that you can’t deliver your already-manufactured products to your customers. |
Distribution |
Many companies have disrupted their own supply chain by leveraging new digital tools, systems, and AI to drive efficiencies. The goal should be 100% on time. |
