The conflicting metrics in your business

Cash Conversion Cycle (CCC)= Days Inventory Outstanding + Days Sales Outstanding — Days of Payable Outstanding

One of the metrics is the Cash Conversion Cycle (CCC). For non finance majors, CCC is a unit of measure for how efficiently a company manages inventory, accounts receivable (AR)and accounts payable (AP). Investors and analysts use this number to compare different companies within the same industry. Thus, efficient management of CCC is correlated to good stock returns. Corporate treasurers manage to CCC by holding onto as much cash as possible, often by extending terms on accounts payable (AP).

Not surprisingly, payment terms continue to increase globally, with average days payable outstanding (DPO) for large corporates (more than $1 billion in GAAP COGS) ranging from a low of 31 days in to a high of 120 days.

As effective as extending payment terms is to minimise risk and protect cash, the strategy sinks other business metrics: those tied to your supply chain health.

Supply chain disruption results in an inability for the buying company to meet demand. Metrics that result from supply chain issues include reductions in revenue, return on investment, production and market share. Or, it can result in a higher cost of goods from suppliers.

Like CCC, supply chain health impacts your status with investors and your cost of capital. Supply chain health is harder to measure than CCC, but it impacts returns. Some researches suggest that in 17 of the 20 largest manufacturing industries, higher shareholder returns correlated with shorter payments to suppliers and a stronger supply chain.

CCC metric is relevant for all kind of businesses — small and large. We have been working with 100s of small businesses to solve their WP issues, and we see CCC challenge exist in almost each case. Majority of those businesses are having issues with managing the inlet/outlet of money. When that balance is broken, either businesses are suffering from insufficient cash in bank, or cost of capital increases significantly.

We believe managing cash is one of the key components, if not the highest priority one, in managing a business. Especially for a small business — because money outlet is big, but money inlet is pretty small for them. Hence if they do not manage their CCC effectively, there is a greater chance that the business is suffering from insufficient fuel to grow.