Cash is the lifeblood of any business. Even the most successful company is doomed to failure if it cannot meet its obligations, and growing businesses often face the most serious cash flow crises as they need to invest in stock, plant and people before being paid by new customers. So how do you ensure that you don’t become a victim of your cash flow? The answer is to improve your cash conversion cycle.
In short, the cash conversion cycle is a metric that expresses the number of days it takes you to convert purchases of stock and raw materials into cash. Put another way, it measures the length of your production and sales process before your investment and hard work pays off. The metric is calculated as follows:
Cash cycle conversion
Days for which inventory is outstanding
This means the number of days it takes you to sell the entire inventory. As you might expect, the smaller the figure the better.
Days for which sales are outstanding
This means the number of days it takes you to collect cash on your sales - and once again you should aim to reduce this figure.
Days in which you pay your own invoices
Almost certainly, you will buy your stock on a credit basis and pay in arrears. Therefore cash does not leave your account until you actually make payment – and the longer you can wait, the better for your cash flow.
What does the cash conversion cycle mean to you?
As can be seen, the cycle doesn’t simply measure how long it takes you to translate stock into final materials or sales. It also takes into account how long it takes your customers to pay you – and how soon you pay your suppliers.
Clearly, there is a balance to be struck: you want to be paid as quickly as possible, but you don’t want to damage your customer relationships with overly aggressive credit control. Similarly, it will benefit your cash flow to pay your suppliers as late as possible, but if you string it out too long you could encounter late payment penalties – or find they choose not to do business with you again.
How asset finance can help
Many companies don’t just need to buy and process stock before getting paid: they have phased delivery and installation requirements and substantial associated costs. In the short term, these tend to be funded by the cash flow, causing significant financial strain. With asset finance the project can be broken down into phased payments for customers, with your business receiving payments directly from the finance company and minimising cash flow difficulties.
Thus, the cash conversion cycle is transformed. If in our original cycle you buy supplies on day one, pay for them on day 30, sell them to the customer on day 90 and get paid on day 120, your cash cycle would last for 90 days (the time between paying your supplier and getting paid yourself). Introducing asset finance might mean you get paid on day 95, reducing the cycle from 90 days to a much more manageable 65.
What’s more, by offering your customers asset finance as a payment option you can order stock only after the finance has been confirmed and the order signed, which will reduce your cash out to cash in timeframe even more.