HOW TO REDUCE YOUR CASH CONVERSION CYCLE
I am very pleased to seeing you all again.
Generally, consumers expect the turnaround time between order and delivery to be as short as practicable. As such, companies that focus on shortening the order-to-invoice period are in a much better position to meet consumers' satisfaction and gratification.
In rapidly changing business environment, customers have grown used to ordering online and receiving a product soonest possible. In order to meet their expectations, manufacturers need to shorten the time between order and delivery.
In order to stay competitive in business, every business need to take advantage of every opportunity to contain or cut costs. As such, decreasing the order-to-cash cycle is crucial so as to preserve margins and profitability. Similarly, this issue will be even more crucial especially for those industry players who have a very thin margin. Bear in mind that high margin will attract more new players to come into the industry and eventually will erode the margin.
The cash cycle comprises of three components: Accounts Receivable, Inventory and Accounts Payable. The first two components, which are out-of-pocket, tend to lengthen the cash cycle because this cash is out to fund your inventory and sales. On the other hand, the third component often shorten the cash cycle, if it is not of cash terms. Therefore, to measure the components of the cash cycle, you need to compute the above three components in terms of days such as Days Receivable, Days Inventory and Days Payable. The Cash Cycle equation will be as follows:
Cash Conversion Cycle Equation = Days Receivable + Days Inventory - Days Payable
The questions to shorten cash cycle become relevant and imminent in any industry
1. Accounts Receivable
Express in term of Days Receivable, period taken for your customers to pay for products or services. The Days Receivable ratio is very much dependent upon your credit policy. However, you may allow your customers less days than your credit period to pay their bills and your Days Receivable. Hence you are doing an acceptable job of collecting cash from your customers in less days than your credit period.
Similarly, inventory is also calculated and expressed in term of Days Inventory. This is the period it takes for inventory to be produced and sold. Generally, your Days Inventory will be very much dependent upon the nature of business and industry you are in. It is obvious that the less days you hold inventory the better it is. This is because both ratios will benefit the cash cycle. For service companies without inventory, parts, or other merchandise, Days Inventory will be zero. You can also recognise, by now as why lots of manufacturers practise just in time concept for their components or parts and materials.
To achieve best-in-class performance, the following actions may be pursued:
a) Real-time status of order, delivery and billing information;
b) Standardize and automation procedures for order process such as order management, fulfilment and delivery, credit and billing management;
c) Employ work-flow automation for major and critical process steps; and
d) Implement build-to-order
The above will enable shortening of the order-to-cash cycle. The enterprise resource planning (ERP) involves full integration of order entry, procurement, production and resource planning and execution as well as financial management; work-flow automation; event management (triggers and alerts); electronic interfaces to banks and customers; Web-based and electronic sales order management application; credit management solution; and an electronic invoice and payment solutions offers the ideal solution.
3. Accounts Payable
It is also expressed in term of Days Payable, which is the period for you to pay your bills to suppliers who may have allowed you credit terms. These vendors are likely supplying materials or services that you use in offering your products or services. Therefore, Days Payable ratio will also reflect your payment policy. The relationship with supply chain members and the tools used to communicate quickly and accurately play a significant role in minimizing the order-to-cash cycle.
From the above discussion, to improve or reduce cash conversion cycle, you need to know what to do, install the tools to do it and train your employees to use those new tools so as to ensure you reap its objective.
So, read it and you'll be well rewarded.
Chief Value Creation Officer