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The Cash to Cash Cycle Final of Series
Part One: Inventory
Part Two: Accounts Receivable
Part Three: Sales and Marketing
Part Four: Accounts Payable
In the past four weeks, we've brought to light four key areas in which you can save $250,000 each -- for a total of $1,000,000. Point by point, we've shown you just how cash flows through these areas, making up the Cash to Cash Cycle.
And as we've seen, the cash cycle is undoubtedly the single most important process to optimize for any business – from when you spend money to when you get money.
So now let's put it all together.
Cash to Cash Cycle Definition
By definition, the cash to cash cycle is a financial ratio that shows the length time for which a company must finance its own inventory. It measures the number of days between the initial cash outflow (when the company pays its suppliers) to the subsequent cash inflow (Accounts Receivables).
Cash Conversion Cycle and Cash Flows
One way to express this is the length of time between the purchase of Inventory (raw materials, etc) and the collection of accounts Receivable created from the sale of your product -- also called the cash conversion cycle.
Why is this most important? Because this is your cash flow and because…
Operations Assessment and Working Capital
Businesses live and die by the cash generated from operations. If your operations don’t create cash, then they consume it. A cash-consuming operation means that you have negative cash flow and you are living on financing (debt or equity). But the Cash to Cash Cycle also shows you the amount of working capital you have committed to your organization.
Just add the number of days of inventory to the number of days of receivables outstanding, and then subtract the number of days of payables outstanding. The result is the number of days of working capital your organization has tied up in managing your supply chain. This can be quite a significant number, not one to overlook.
This can also be expressed by the formula: stock days + debtor days - creditor days. So a company which keeps its stock for on average 20 days, which gets paid by its debtors on average within 30 days and which pays its creditors on average within 45 days, has a cash-to-cash cycle of 5 days. So, for example, a company which keeps its stock for on average 30 days, which gets paid by its debtors on average within 30 days and which pays its creditors on average within 45 days, has a cash-to-cash cycle of 15 days.
Companies that receive cash from their customers at the point of sale and that have their inventory under good control will have a short cash-to-cash cycle.
Processes and Procedures Investments and Inefficiencies
Did you realize that working capital is the investment you are making in the inefficiencies of your processes and procedures plus your investment in your suppliers’ and your customers’ inefficiencies too?
But wait, we are still talking about the cash to cash cycle, right?
Policies and Procedures Savings
That’s right, so now you can see the relationship between your cash flow, your working capital and your cash to cash cycle. In order to increase your cash flow, you need to increase the velocity of your cash to cash cycle by reducing the inefficiencies found in your processes, your suppliers’ processes and your customers’ processes. The result is a decrease in your working capital and an increase in your cash. And, as we've seen, this can be a significant number that you shouldn’t overlook.
Chris Anderson is currently the managing director of Bizmanualz, Inc. and co-author of policies and procedures manuals, producing the layout, process design and implementation to increase performance.
To learn how to increase your business performance, visit: Bizmanualz, Inc.
