Hack the Cash Conversion Cycle
Small Improvements, Big Results
By Tommy D’antonio, Analyst at Fluent
Beyond creating a better product, boosting sales, or coming up with the next viral marketing campaign, effectively managing your company’s cash conversion cycle is a surefire way to improve your bottom line. Small improvements in the cash conversion cycle can have profound effects on working capital and profitability. To illustrate these effects, consider the following two examples:
Suburban Outfitters (SO) is a clothing company with sales of roughly $3.5B and a gross profit margin of 35%. On average, it takes SO 19 days to pay its suppliers, a metric known as days of payables outstanding or DPO. Compared to the retail apparel industry average of 33 days, SO pays its suppliers much more quickly. A modest increase in the days of payables outstanding from 19 days to 26 days would increase the amount of cash SO has on hand by over $45M! With a (conservative) cost of capital of 10%, that’s worth $4.5M in annual interest savings that flow directly into net profit, the equivalent of selling 450k graphic tees without any corresponding increase in costs!
Blue Mountain Coffee (BMC) is a coffee supplier with sales of roughly $4.5B. On average, it takes BMC 42 days to collect money owed by its customers from sales on credit, a metric known as days of sales outstanding or DSO. Compared to the packaged food industry average of 26 days, BMC has a much slower collection process. A modest reduction of the days of sales outstanding from 42 to 34 days would increase the amount of cash BMC has on hand by over $100M! Again, with a (conservative) cost of capital of 10%, that’s worth $10M in annual interest savings that flow directly to the bottom line, the equivalent of selling 16M k-cups without increasing costs by a single penny!
The cash conversion cycle is one of the key levers for managing working capital and maximizing profitability. Smart use of trade finance instruments and negotiating favorable payment terms with suppliers is the most effective route to safely extending DPO and shortening DSO. As a CFO, your focus should be searching the market for products that help manage and improve your cash conversion cycle. Show even modest improvements in CCC, and you will be the hero of your organization as it will have a significant impact on liquidity and your bottom line.