The Boston Consulting Group did a study of the cash conversion cycles of 122 fast-moving-consumer-goods companies from 2006 through 2009, and the results were incredible: by simply being more efficient with their inventory and receivable cycles, they estimated savings from $100 million to $1 billion. This is a great example of how a simple, often overlooked operating principle can make such a large difference. Now chances are that your company isn’t large enough to see millions in savings, but this article gives a few simple tips for even the average-sized Utah company to save significant money.
Understanding the Cycle
The cash conversion cycle is basically a metric to measure how efficiently you are using your net working capital, or how well you are optimizing your current assets and liabilities. It reports the number of days that your money is tied up between paying for materials and receiving money from customers for the sale of those goods.
It may take a few minutes to get the intuition down, but the important thing is paying attention to how long your cash is tied up. The goal is to have the number of days in the cycle as low as possible. Think of it this way; the longer you can put off paying your suppliers and the faster you can turn your inventory and collect money from your customers, the more cash you will have freed up for operations. It is calculated by days in inventory minus days payable outstanding plus days sales outstanding. The details can get deeper, and the services of a temporary CFO can help with a more in-depth analysis.
It is easy to see that the more efficiently you can turn your inventory and collect receivables, the more cash you will have in the coffers. That means less interest to be paid on revolving credit lines, more employees that could potentially be hired because you have more cash available, and the more attractive your company will be to outside investment. Here are a few ways you can improve the process:
- Use your relationships with your suppliers to lengthen your payables period. If it’s currently 15 days, see if they will let you go 30 days before writing them a check.
- Depending on your customers, you may be able to collect faster or time your sales to match when they are able to pay you. For example, you may be able to get lead-time on your customers’ plans to purchase so that you order inventory only days in advance of when their purchase order is likely to come in.
- Be more efficient in your billing process. An automated or speedy invoice process can help as the customer will have the bill in their hand that much faster. Gentle reminders at 10 days and 15 days can also help keep your bill front and center on their desk.
- The last one is improving inventory turnover. Find ways to get your inventory out the door more quickly, instead of collecting dust on the shelf. Work with a specialist to try and forecast the amount of inventory you need to have on hand for each of your SKU’s.