What do you often think about business growth? What is the heck behind lean productivity, profitability, and good relations with suppliers and customers? This is how Cost and value are distributed throughout the Supply Chain. Business Growth, Profitability, and internal and external customer relationships solely depend on Cost. Even so, the game-changer in the fast-paced business world is how well you manage the Cash Conversion Cycle throughout the Supply Chain. After all, it is not just a tool to streamline the cash process but it inevitably contributes to the growth of the business.
The Cash Conversion Cycle greatly impacts businesses that deal with inventories. It is a useful tool for determining the holistic status of the financial aspects of the company. Illustratively, the major role of the CCC is for businesses that revolve around inventories, such as retail stores, wholesalers, manufacturers, etc.
The cash conversion cycle does not play any role for businesses that do not deal with inventories, such as service industries, software houses, insurance companies, etc. Even so, one of the best ways to identify the key performance of the Working Capital is to know the Cash Conversions. CCC best identifies how well the working capital is invested, managed, and received back.
Role of Cash Conversion Cycle
The CCC depicts the holistic view of business cash flow. It indicates how seamlessly and smoothly cash is managed throughout the supply chain. Moreover, it pertains to the effective way of investment, acquiring the inventories, supplier management, handling of inventories over time, and selling it to customers. Then, using that cost to pay the vendors and suppliers. A non-efficient conversion cycle indicates inadequacies in the business. Causes and effects of the discrepancies in inventory management and resources, slow receivables, and slow cash flow and payment of suppliers.
In addition, it seamlessly provides businesses with identifying growth opportunities. It hallmarks the current financial status of the overall business. Also, helps in pinpointing the inefficiency in inventory management, receivables (credit or cash) gaps, and delayed payments to the customers.
Want to learn about effective Negotiation? Here, have a look at our comprehensive course “Introduction to Negotiations Process” on our Website!
What is the Cash Conversion Cycle?
So, let’s have a look at what is the Cash Conversion Cycle? that seems very significant in overall business performance.
“The Cash Conversion Cycle is the financial metric that helps businesses to identify what is the right investment, and how it will turn the investments in inventories and resources. Next, inventories and resources into cash from sales.“
The Cash Conversion Cycle is also called Cash Conversion or CCC. The main aspect for consideration of the CCC is Cash and Time. Both imply the management of the overall operational and financial efficiency.
What is the Cash Conversion Cycle Formula?
The CCC depends on three components. Yet, all three components play an impactful role in the calculation of the CCC. The Cash Conversion Cycle formula is:
Where, DIO = Days Inventory Outstanding
DSO = Days Sales Outstanding
DPO = Days Payable Outstanding
Let’s learn what are the three fundamental components of the Cash Conversion Cycle and what they indicate.
Components of the Cash Conversion Cycle
The Cash Conversion Cycle is fundamentally based on three components. Days Inventory Outstanding, Days Sales Outstanding, and Days Payable Outstanding. Below are the brief details of the components:
Days Inventory Outstanding
Firstly, this calculates how many days on average it will take to sell your existing inventory. That means Cash is held in the form of inventory on your shelves. Ideally, the shorter the period of inventories on the shelf, the faster you cash up.
Optimise Inventory Planning with this Free Inventory Ageing Report
Days Sales Outstanding
Secondly, this calculates how much time it will take you to collect payments from the customers after sales. Sale Payment can be Cash or Credit. Days Sales outstanding are less, overall cash cycle improves.
Days Payable Outstanding
Thirdly, this calculates the period you take to pay your suppliers. Businesses should pay their suppliers on time and should have strategic alignment to have a payment cycle. Moreover, it plays a significant importance as it improves the relationship between businesses and suppliers.
Learn more about Procurement strategies by our course “Mastering Procurement – Essential Skills and Competencies” on our Website!
Examples:
Let’s consider a manufacturing unit that manufactures sports goods. The Turnover inventory on average of the football is 14.2 days for each batch. Consequently, it takes 18.8 days to receive payments from the customer, and it takes 16.3 days to pay suppliers. So, what will be the CCC for football?
Solution:
We have,
Days Inventory Outstanding for football = 14.2 days
Days Sales Outstanding = 18.8 days
And, Days Payable outstanding = 16.3 days
Here, the Cash Conversion Cycle formula is
CCC = DIO + DSO -DPO
= 14.2 + 18.8 – 16.3
CCC = 16.7 days
It means it will take 16.7 days for the football business unit to convert cash into inventories and recurring the cash.
What does the Cash Conversion Cycle interpret?
The shorter the period of the CCC, the more efficient the Cash Conversion Cycle is. The shorter time shows the conversion of investment into inventories and then into cash is quicker which shows it is productive.
Whereas, the longer the period of a Cash Conversion Cycle, the less efficient the CCC is. The Longer Cash Conversion Cycle indicates the loopholes in the system such as inefficient inventory management, slow payment collections, or non-timely payments of suppliers.
Sometimes the Cash Conversion Cycle is also Negative. In fact, the negative CCC indicates that the inventory is sold before the payment cycle. Negative Cash conversion is ideal to achieve for the businesses.
What is the Good Cash Conversion Cycle?
Businesses that have an average Cash Conversion Cycle between 30 to 45 days count as a good Cash Conversion Cycle. It shows that businesses can get the cashback with profits after turning it into inventory through investments. The quicker the CCC is the more efficient the cash flow of Working Capital.
Best Practices to Optimize Your Cash Conversion Cycle
Operations efficiencies and effective liquidity of the business can be achieved by adopting the best practices of CCC. Some best practices are listed below:
Assess the Current Cash Conversion Cycle
Compute the current Cash Conversion Cycle of the business. Where it is standing, what are the targets, and what are the bottlenecks? This can be a higher number of days in the selling of inventories or it takes many days to collect the payment from customers or businesses failing to pay suppliers on time. This all collectively affects the Cash Conversion Cycle negatively.
Have Effective Inventory Management
Inventory Management is the crucial process for keeping a good Cash Conversion Cycle. You can adopt the practice of Just In Time (JIT) to have the efficiencies in Inventory Management. It helps in identifying the excess stock resulting in freeing up stock. Also, helps in cutting down storage costs.
Learn more about Inventory Management Fundamentals for Supply Chain on our Website!
Explore more about effective Inventory Optimization Tool in Excel – Inventory optimization model on our YouTube Channel!
Focus on Receivables
Make a strategic approach for the receivables. Pay core attention to policies on credit and payments. Improve inflows by offering bonus points to customers. It will improve the inflows.
Strong Relationship with Suppliers
Have developed and mature suppliers that align with your long-term goals. Don’t hesitate to negotiate. Emphasis offers interesting deals against attractive prices.
Struggling with Supplier Relations? Learn more about Effective Supplier Relationships through our course
Benchmark with Competitor
Know your competitor Cash Conversions. Benchmark and stay informed about your business performance. Also, it will help you to evaluate your current status and help you make realistic goals and improved strategies.
Concluding Remarks
In conclusion, managing effective cash flow is not just about financial alignment. It pertains to the growth opportunities for the business. It improves businesses’ growth potential. Businesses that deep dive in their businesses have more growth opportunities, and can better enhance their inventory efficiency with improved supplier relationships. Efficient Cash Conversion helps businesses to reinvest more quickly. Moreover, an optimized CCC or Conversion cycle formula allows businesses to respond more quickly, which will give businesses an edge over Customers.
Head to our Website to decode Supplier Costs
About the Author – Dr. Muddassir Ahmed
Dr. Muddassir Ahmed is the Founder & CEO of SCMDOJO. He is a global speaker, vlogger, and supply chain industry expert with 19 years of experience in the Manufacturing Industry in the UK, Europe, the Middle East, and South East Asia in various Supply Chain leadership roles. Dr. Muddassir has received a PhD in Management Science from Lancaster University Management School. Moreover, Muddassir is a Six Sigma black belt. He has founded the leading supply chain platform SCMDOJO. It enables supply chain professionals and supply chain teams to thrive by providing best-in-class knowledge content, tools, and access to experts.
You can follow him on LinkedIn, Facebook, Twitter or Instagram.
