The impact of Covid-19 has shown us that even profitable businesses can go broke if they run out of cash. Understanding and managing your cash conversion cycle frees up your cash and helps you build a cash war chest to get you through tougher times.
Your cash conversion cycle is the number of days your cash is tied up to take your goods and services through the sales process.
The formula for calculating your working capital cycle is:
Stock (or work in progress) days + debtor days – creditor days
Where stock days = stock / annual sales x 365
Debtor days = current debtor balance / annual sales x 365
And creditor days = the number of days until you need to pay your suppliers
For example, if your stock days are 45, debtor days are 60 and credit days are 30, your cash conversion cycle is 75 days.
Assuming daily sales are $5,000, the business will need either cash on hand or access to a line of credit of $375,000 to stay afloat ($5,000 x 75 days).
To shorten your cash conversion cycle, consider the following strategies:
- Reduce your stock holdings.
- Invoice more often.
- Change your payment terms.
- Use a debt collector or credit controller.
- Negotiate more favourable terms with suppliers.
Get in touch to learn how our Cashflow & Profit Improvement Meeting can help you shorten your cash conversion cycle and free up cash in your business.
“Making more money will not solve your problems if cashflow management is your problem.” – Robert Kiyosaki
