Most of us know that cash to cash cycle is the period in which the portion of working capital (cash) is out of reach of your business. It means that shorter the cycle, leaner your business is. In other words, cash to cash cycle depends on three major factors:
- Outstanding invoices from your customers
- Capital deployed in inventory
- Outstanding payable invoices of suppliers
Putting this in a formula, it will become as:
Cash to Cash Cycle = Period sales outstanding + Period cash is locked as inventory – Period cash is free as business did not pay its invoices
Period in above formula will remain constant for all three variables and normally it is taken as one day.
The most obvious targets from above formula, for reducing the cash to cash cycle are reducing the number of days of customer outstanding, reducing inventory and increasing the number of days, we take to pay up suppliers and rightly so but the way of doing it, is often wrong. Some organizations will start pressurizing suppliers to accept more than 60 days or even 90 days as payment terms to shorten their C2C cycle and this can be dangerous as your suppliers viability is at stake and either you will see a growing rift between yours and supplier organization, reduction in quality, increase of prices whenever they get chance or suppliers moving away from you altogether.
Another mistake we normally do is to start reducing inventory indiscreetly instead of looking at the ways how the inventory can be moved faster by offering discounts on slow moving items, by improving the lead times of inventory receipt at your warehouse or by working with suppliers for moving towards just in time inventory etc. The reduction in inventory though will give you shorter C2C cycle but can also trigger multiple stock outs bringing down business and customer satisfaction.
The third mistake is little difficult to achieve as it includes the customer but we see this also often. The organizations not only stop offering credit to customers but also start asking about advance payments in certain cases. No need to say, what impact, this will have on your customers and will they not move away from you given the first available opportunity. Instead, we should focus on improving speed invoice issue and processing, improve response to disputed bills, reduce invoicing errors and reduce the incidents of bad debts. These internal measures will make sure that you are not playing a one sided pressure game and not making your partners pay for your operations. Instead you truly will achieve lean operations and reduction in cash to cash cycle will automatically come as a byproduct.
Now, please don’t ask me, what do I do if my cash to cash cycle is zero (yes, it can achieved) and I have excess cash. Go acquire a target company or pay bonus to your employees or start a new product or service range etc. – the list is endless and fruitful.