What’s your cash flow cycle? Is your business running on a 30-day cycle? 45? 90? The quicker and more efficient your cash flow cycle, the more time you can spend harvesting the rewards of business, as opposed to the gymnastics of managing Accounts Receivable (AR). You can leave the grind behind—and claim the envied status of “Finder” instead.
The basic cash-to-conversion cycle—the time lapse between your own payments (say for services, payroll, raw materials, etc.) and the realization of corresponding revenue—is crucial to the success of any business.
For manufacturing companies, to calculate the cycle you factor inventory periods with average COGS payment as follows:
(The number of days in inventory + days outstanding) – the average payment period for COGS
For service companies, you apply this formula:
(The number of days of revenue required to cover period staffing costs + number of days outstanding) – the average payment period for payroll and consumables
If your cycle exceeds 35 days, problems abound. As a business leader, you may end up focusing your energy on getting information on collections, making cash forecasts, and trying to stretch-out cash versus taking actions that generate new revenues.
Trends and Benchmarks—Measures of Efficient Cash Flow
To get a true feel for your cash flow cycle, you can’t just take a one-time snapshot. You need to see a trend over several periods (e.g., six months) or benchmark your numbers against an industry norm, such as those from American Productivity & Quality Center (APQC). APQC surveyed close to 4,000 companies on their cash cycle. They found that, on average, companies realize cash-to-cash in 45 days. However, well-run companies realize cash-to-cash in 30 days or less. That’s an astounding 33% improvement over their peers. Not only does this offer a significant cash boost (and a corresponding lack of stress), read on for additional strategic advantages.
On the opposite end of the spectrum, the worst-run companies took 80 days or longer to complete the cycle. Companies with an extended cycle are at a huge disadvantage for obvious reasons—chiefly, focusing substantial time and effort on collecting versus creating.
Better to be a Finder Than a Grinder
One of the best ways to envision this disadvantage is through the business leadership concept of Finder, Minder, and Grinder. Grinders spend their work day focusing on the daily work process, and getting the tasks before them completed and out by the end of the day. B2B CFO founder and distinguished thought leader, Jerry Mills, wrote an entire book about this, entitled The Danger Zone.
Minders focus on what has happened—they put more emphasis on the rear-view mirror and recording or tracking activity. They act like controllers or office managers. Compare this to their more effective peers (or better yet, their high-performing competitors!).
Unlike the other two, Finders focus on generating new thought flow, new revenues, developing products, and exploring potential partnerships for future business development. Imagine taking all the time and energy required to grind out day-to-day cash flow or minding the past, and instead applying it to finding new sources of income.
Small Changes in Process Make a Big Difference
Leaders of companies that fall in the 45 to 60 day cash conversion cycle, or even the 90-day cycle, can make adjustments to their processes and realize significant improvements.
For example, I recently helped one of my clients cut their conversion cycle by a third. This remarkable change of status wasn’t the result of wishful thinking, but of strategic analysis and implementation. I started by studying the company’s financial statements, weekly cash management process, and accounts receivable aging.
What I found was that my client is excellent at promptly shipping their product. However, it typically took them 30 days to send out invoices. AR lagged an average of 60 days behind shipment. The delayed invoicing, compounded by other factors, resulted in an untenable cash conversion cycle of more than 90 days. After making adjustments in inventory acquisition, an upgrade in staff, and moving to same-day ship-to-billing, the cash cycle is now 35 days. The owner is no longer chasing money, now he’s reeling it in.
Improving Cash Flow Starts Here
If your business is having difficulty time paying bills on time, you may think your only recourse is to look for outside avenues for cash, extend or obtain a new line of credit, or secure new capital for business growth. Instead, you should first look inside your business.
The revenue can already be there, but mistimed inflow is costing you crucial opportunities. Fees, interest, even relinquishing some ownership are the heavy price you pay for an extended cash flow cycle. Change doesn’t have to be disruptive to produce significant ripple effects. Knowing where to look and what to modify can have you finding cash – inside and out.
Dennis McIntosh is a finance executive and experienced CFO with expertise driving high-impact business growth, transforming financial operations, and helping owners exit their business. He is a partner with B2B CFO Partners, a national consulting practice providing financial services to privately owned companies.