How long does it take you to convert your products into cash?
This is one of the most important but overlooked measures in most businesses I see. It goes to the manner in which you manage all the processes and resources it takes to turn ideas, products and services into cash, the lifeblood of every enterprise.
Your Cash Conversion Cycle, (sometimes called cash to cash cycle) is the time from the order of raw materials, in the case of a manufacturer, to the payment of the invoice related to a sale. In other words, days inventory (which includes raw materials, Work In progress, and finished goods), plus days debtors outstanding, minus days creditors outstanding.
Reducing your cash conversion cycle time can be a huge competitive advantage.
There are a number of well understood ways to reduce your CCC, the catch is, that it is a delicate balancing act between differing functional responsibilities.
In the pre-deregulation milk industry in NSW, my then employer, Dairy Farmers, paid the dairy corporation for its milk, as all production was vested in the corporation, in 30 days. We sold to milk vendors, the monopoly distributors, on 7 days terms. This gave us a -23 day cash conversion cycle. On the day of deregulation, from which retailers could buy from whoever they wished, that cycle changed radically. We paid the dairy farmers, our suppliers, in effect, C.O.D., and supermarket retailers paid us 90 days. Our cash cycle went from -23 days to +90 days for supermarket sales, a 113 day turnaround overnight, which cost in the region of 60 million dollars in working capital.
It was a big pill to swallow.
So, what are the strategies that can be employed to improve your cash cycle time?
Reduce inventory.
Physical inventory in a service provider is not a consideration, as there is none beyond consumables. However, in most cases of service businesses, there is some sort of project involved, which takes time to deliver. In this case, time can be considered as inventory, and the quicker the ‘inventory turnover rate’ the better.
A manufacturing business generally has inventory in three parts: raw material, Work in Progress (WIP) and finished goods. While it is tempting to manage each separately, the downside is the potential impact on customer service, so they must be managed together.
- Purchase reduction. Too many times I have seen a Purchasing Manager instructed to reduce inventories, which is easily done by simply reducing purchases. However, done in isolation, this almost always leads to manufacturing shortages, and angry customers.
- WIP reduction. Similarly, WIP is often seen as relatively easily reduced by doing longer manufacturing runs. The unfortunate consequence of which is usually increases of finished goods inventory of slower moving lines. When there is a multi-stage manufacturing process, longer runs also leads to WIP build-up in front of slower manufacturing sub-processes.
- Finished goods reduction. Finished goods are the most expensive inventory items, as you have added time, labour and the input materials to produce them. Nevertheless, being out of stock when a customer orders is never good. Alternatively, depending on your business model, putting their order on a future delivery date can be managed, but the longer the delivery lead time, the more likely the customer is to go elsewhere.
The upshot is that inventory can be reduced, often by substantial amounts, but it takes leadership, functional collaboration, and appropriate performance measures to be successful while retaining customer service.
Decrease debtor days
Debtor days are a function of both your trading terms and diligence in collecting debt as it becomes due. A strategy that usually works, is a polite reminder that the invoice is due to be paid in a few days. It is too easy to leave debtors to pay their bills as and when they are able. A bit of friendly, polite pressure applied might see your invoice go to the top of the pile, at least over those who do not actively and politely follow up. Diligence, and being a very polite ‘squeaky wheel’ pays.
Another useful way to reduce debtor days is to split payment. When selling some items you can reasonably have as a part of your trading terms a deposit, and partial payments over the period between order and final delivery. This happens when you build or renovate a house, there are stepped payments in line with project milestones. Think creatively about how you might introduce similar stepped payments, your cash flow will love you.
Manage creditor days
Managing creditor days is not just a matter of delaying payment, although this is the most common reaction. Your suppliers are in the same situation you are, setting out to reduce their cash cycle time, and if you are a recalcitrant debtor to them, they will tend to reduce their levels of service, demand C.O.D., or even simply refuse to supply. Secondary to a shortened cash cycle is a reliable cash cycle. If your suppliers know from experience, and negotiation, you will pay the invoices on a given day, they will tend to leave you alone, or even agree to an extension of terms. In effect they are exchanging a shortened cycle for a reliable one. Experience tells me paying exactly to the terms agreed is the best strategy, as it enables renegotiation of those terms.
Management of cash is an essential discipline for success, and the time it takes to convert an order into cash is about the best measure there is to proactively manage your procurement, manufacturing and sales demand planning processes. Out of measuring the cash conversion cycle time will come a number of contributing measures that will together make the enterprise more competitive, resilient, and agile.
This is all pretty simple to say, but like most things in life, much harder to do. When you need an experienced hand, give me a call.
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