If you’re not a numbers person, understanding your Cash Conversion Cycle might sound like more trouble than it’s worth – something you can leave to your accountant. But it’s a worthwhile metric for any business owner, and it’s surprisingly easy to get your head around.
Put simply, the cash conversion cycle explains how quickly your business turns cash around – the delay between buying from the supplier, manufacturing, selling product, and receiving payment. If you’re a service provider, it’s about how long it takes to receive payment after billing.
The shorter your cash conversion cycle, the better your cashflow, and the easier it is to build your business.
Calculating Cash Conversion
The Cash Conversion Cycle is a metric that can help you understand how your business works – but there’s no one perfect cycle for every business.
For service providers, the cycle is relatively simple. You provide a service, invoice your customers, and then wait to receive payment. The average length of time between service and payment is your Cash Conversion time.
If you’re a manufacturer or importer, the cycle gets a bit more complicated. Your business buys supplies from vendors, pays the vendor, makes the product, sells it on, and then receives payment. Your conversion time consists of the days between paying the supplier and receiving payment from the customer. The length will vary depending on your manufacturing process, how long your store the product before it’s sold, and how long your customers take to pay you.
The shorter the better
Although there’s no one ideal length of cash conversion cycle, shorter is generally better. The quicker your turnaround from product or service to payment, the better your cashflow. Rather than having outstanding invoices, you’ll have cash to use in your business.
A slower cycle can cause problems – if your cycle is 90 days, for example, you may not be able to buy supplies and manufacture new product until older product is sold. This means you won’t always have the right stock on hand when customers want it, which could lead to lost sales.
If you’re a service provider and you’re waiting on customers to pay their invoices, you may not have the cash on hand to pay staff, bills or for marketing – this could mean staff dissatisfaction, late payment penalties or lost sales.
Interest is another factor. Cash sitting in your bank account earns interest, but if it’s sitting in your warehouse or your clients’ accounts, you’re essentially losing money.
Speeding up your cycle
Understanding the Cash Conversion Cycle can help you identify weak points or roadblocks in your business. If you believe your cycle is longer than it could be, there are a number of ways to shorten it. Even a few days here and there could make a big difference.
It all depends on how your business works, the product or service you’re offering, and how flexible your suppliers, vendors and customers can be. Every organisation will have processes or systems that could be improved, and areas that are set in stone.
Ways to shorten your Cash Conversion Cycle:
Sort out your invoicing – invoice customers as soon as possible, and consider penalties for late payment.
Cash or credit? Think about whether it’s worth offering delayed payment at all.
Better billing – negotiate with suppliers and vendors so you can pay them later in the month.
Manufacturing and delivery – look for ways to shorten your manufacturing process and tighten your delivery time.
Product selection – if you have some product that’s always sitting around on shelves, it may be worth changing your product selection to speed up sales.
Of course, your Cash Conversion Cycle isn’t the be all and end all of business improvement, it’s simply a useful measurement of your performance – and a helpful way to find roadblocks in your business. As always, when it comes to running a business, the more you know, the easier it is to make strategic decisions.