March 13, 2023
Many entrepreneurs and leaders are concerned about what will happen to their business when the economy starts to slow down.
With increasing signs that the global economy is getting worse, more employees are starting to ask whether the company has what it takes to not only survive the economic crisis, but to come out of it stronger as well.
If there’s one thing that entrepreneurs and leaders need to know, it’s to keep a close eye on your Cash Conversion Cycle during turbulent times.
The cash conversion cycle (CCC) is a metric that shows how many days it takes for a company to turn the investments in inventory and other resources into cash flows from sales.
Its function is to figure out how long it takes for each net input dollar to be used in production and sales before it is turned into cash. This metric takes into account how long it takes the company to sell its inventory, collect its receivables, and pay its bills.
The cash cycle is an important measure of a company's working capital for all businesses that purchase and manage inventory. It reflects the efficiency of their operations, the risk of running out of cash, and the overall health of a company's finances.
CCC is based on figuring out how long each of the three stages of the cash conversion life cycle takes in total. The mathematical formula for CCC is:
DIO = Days of Inventory Outstanding
DSO = Days Sales Outstanding
DPO = Days Payables Outstanding
DIO and DSO are related to cash coming into the company, while DPO is related to cash going out of the company. Basically, DPO is the only number in the calculation that goes down. Another way to look at how the formula is made is to realize that DIO and DSO are linked to inventory and accounts receivable, which are considered short-term assets and are taken as a positive. Accounts payable are a liability, so they are counted as a negative.
The average length of the cash conversion cycle varies a lot from one industry to the next. This means no single number can be used to describe a "good" or "bad" cash conversion cycle.
However, comparing the CCCs of two companies in the same industry can be helpful because a lower CCC could mean that one company is better at managing its working capital than the other. It can also be helpful to keep track of a company's CCC over time, since this can show if the business is getting more or less efficient.
Since DIO, DSO, and DPO are all part of the CCC, a high (bad) CCC may also be a sign of certain problems. For example, it might take a long time for a company with a high CCC to get paid by its customers, or it might not be good at predicting how much demand there will be for its products, which means it takes a long time to turn its inventory into sales. A high or rising CCC could also mean that a company is not making the best use of its short-term assets.
Many people worry when the economy is in a slump. But you could look at the current state of the economy as a chance to improve on the way you manage your business's finances and operations. Then you can make some good changes that will not only help you get through the hard times but also set you up to make the most of a recovery when it comes.
If you’re unsure on how to prepare for a recession or any other upcoming crisis, I’m here to help.
Get in touch with me today.
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