Your heartbeat, blood pressure, cholesterol all levels you keep under check. Though competitive business atmosphere makes it difficult to keep all these health parameters under your control.
One business ratio though can help you to keep your above health parameters in check.
Most SME suffers from a cash flow crisis. This is their daily struggle. The reason their health deteriorates is mainly be attributed to the cash flow crisis. In order to avoid this entrepreneur must focus on CCC.
“Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.” Peter Drucker, management consultant, educator, and author.
CCC is one of the important aspects of managing cash flow.
What is CCC?
CCC is the Cash Conversion Cycle. This indicates how quickly you convert goods into cash.
This is a very important cycle to monitor for every entrepreneur. The immediate sign of slowdown of business and recovery is CCC.
CCC indicates how fast you are converting your goods into cash in hand. Slower CCC means inefficiency or stiff competition. Faster CCC is the aim every business should aspire for.
In simple term, if your buyer pays you in 30 days and your seller wants payment in 15 days, you have working capital gap usually financed by the bank (If you have bankable data to support working capital loan from the bank).
Imagine a reverse scenario. 30 days of creditors and 15 days of debtors. You will have a cash surplus in the system.
CCC can be worked out with the following formula.
CCS = DIO + DSO – DPO
Daily Inventory Outstanding (DIO), Days Sales Outstanding (DSO) & Days Payable Outstanding (DPO).
For example, your business has 30 days of stock, your debtors pay in 45 days and your credit terms with suppliers is for 15 days.
CCC is 30 + 45 – 15 = 60
Cash in the system is Rs. 3000 (Cost of 30 days of stock on hand) + Rs. 4500 (45 days receivable value) – Rs. 1500 (Cost of 15 days of purchase) = 6000
This Rs. 6000 is financed by the bank and your capital. This is how the bank arrives at the working capital gap and maximum permission bank finance (MPBS).
When a business receives advance payment or recovers sales outstanding quickly, CCC improves. When a business has quicker sales recovery, a cash-flush business can negotiate better with suppliers.
Apple is known for superior customer experience. Its CCC has reduced from negative 56 days in FY 14 to negative 87 days in FY 17.
Amazon is another company known for better customer experience. It also enjoys negative CCC of 15.06 in FY 18.
DIO = 27.5 + DSO = 21.02 – DPO = 63.58 = -15.06
Negative CCC indicates the creditors are more than the value of the stock on hand and debtors. The company is working on suppliers’ money.
Companies that are in the monopoly business or are offering superior customer experience enjoys lower CCC.
“We were always focused on our profit and loss statement. But cash flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas.” Michael Dell, founder and CEO, Dell Technologies
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Benefits of Better CCC
- More cash in the system, less need of working capital
Yes, quicker CCC makes more cash available in the system. You are turning goods to cash faster. Cash held up in stock and debtors is available for the business. This reduces the need for external working capital finance.
- Lower interest cost
Lower working capital and more cash in the system lowers the need for a working capital loan and even short-term loans. This reduces interest cost for the company.
If the excess cost sued effectively it can generate some income also for the company.
- More cash means more capital and more business
Fast turnaround of goods enables more sales and more profit per year.
Imagine customer turnaround time for a restaurant. A restaurant which turnarounds customer in 30 minutes can do more business than a restaurant which turnaround in 60 minutes. Same is true for faster goods to cash turn around companies.
- Better price negotiation with suppliers
More cash in the system enables the capacity to pay suppliers quickly. This can give the option for better price negotiation with the suppliers.
- Better pricing capability against the competitor.
A company which does faster cash conversion, turnaround the goods more than the company which has a longer CCC. Company A with 90 days CCC can earn less than company B which does 45 days CCC.
Company B archives double the turnover than company B assuming capital and capacity are the same. This higher sales results in higher profit. Higher profit gives better pricing capability too.
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How to Improve CCC?
In simple terms improve efficiency in debtor and stock management and negotiate better terms with the suppliers.
Better Inventory Management:
- Improving efficiency and lean operations are considered by experts as the way to improve CCC
- Adopt lean operations like just in time and vendor managed inventory to reduce days inventory requirements
- Eliminate wasteful processes
- Do better demand forecasting
- Regularly monitor dead stock and its disposal
Better Receivable Management:
- Have a system of quick and error-free invoicing
- Use the bank’s treasury management products for better cash and recovery management
- Have discount linked to quicker payment
Better Payable Management:
- Reduce the number of suppliers for better negotiation
- Avoid payment earlier than the due date payment
- Reassess and streamline logistics
There is a direct linkage of company profitability and CCC. In a study, it was found that there is strong evidence that working capital management policies still affect profitability and performance.
The study of portfolio companies of high and low CCC firms by applying the Fama-French factors, it was found that firms with higher cash conversion cycles have lower risk-adjusted stock returns.
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Every company has a different structure, culture, and policies. Have a close look at your business processes. Find the area of improvement of effeminacies, focus on cash management and have a targeted timebound mission to lower CCC.
Free-up cash in the system, speed up sales recovery, negotiate better terms with vendors, get rid of dead stock and assets.
Focus on CCC improvement can transform the way you do business. Profit and return rations are the focus of most entrepreneurs but focus on CCC can help in improving other key ratios.
“Never take your eyes off the cash flow because it’s the lifeblood of business.” Sir Richard Branson, Virgin group.
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