Two weeks ago, I talked about the timing of your sales pipeline. Last week I wrote about your cash conversion cycle…
As a refresher, your Cash Conversion Cycle is the number of days – on average – it takes for you to convert working capital to cash.
You start with the number of days it takes to collect your accounts receivable. Then you add that to the number of days it takes to sell your inventory. Finally, you subtract the number of days you take to pay your vendors.
|Business A||Business B|
|Days to collect receivables||40||25|
|Days to sell inventory||15||35|
|Less – days to pay vendors||(15)||(25)|
|Cash Conversion Cycle||40||35|
Quiz – which is better, Business A, or Business B?
Business B. Why? Because it takes only 35 days, compared to 40 days to convert working capital to cash.
How can Business B get even better? By managing inventory better! It is 35 days on average to sell and only 15 days for Business A.
How can Business A improve? By getting paid quicker, and/or paying vendors a bit more slowly. It is taking 40 days to collect its receivables versus 25 for Business B.
Here are 6 ways to increase your cash-flow:
Way # 1 – Order Inventory Later
Inventory is money on the shelf.
I remember touring a warehouse once, years ago, and was shocked to see so many items laying on the floor. Other items were collecting dust. I said, “you know, if those were gold bars, would you treat them like that?”
Ordering the wrong stock too soon is going to tie up your working capital.
Order the wrong stock and you have trouble selling.
Too soon, (before people need or want), and again you have money sitting on a shelf.
An example of “too soon” is buying stock for Christmas in March. That said, if you get a great deal that could be a good business decision.
Inventory management is an art. It is related to three things:
- Timing of purchase
- Ability to re-sell the inventory quickly.
- Availability from suppliers
Way # 2 – Get Deposits from Customers Upfront
I believe Dell Computers had a negative cash conversion cycle because you pay for the computer upfront. Only then do they build/assemble it for you.
When I suggest getting deposits upfront to businesspeople the response is often – “I cannot. My customers will not accept that”.
How do you know? Who sets the terms?
If Michael Dell had asked his customers I am sure they would have said – “we prefer to pay on delivery”.
Michael Dell set the rules and grew a massive global cash-machine as a result.
Way #3 – Get Accurate Invoices Out Fast
The longer it takes for you to issue an invoice the slower the payment. This one needs no explaining, right?
Way #4 – Chase Those Receivables
Once you have sent your invoices – chase them with a system.
We use software that is incredibly friendly, powerful, and consistent. It is fully automated to chase our clients receivables for them.
This shortens the days your receivables are outstanding before becoming cash in the bank.
Way #5 – Only Sell to Credit Worthy Customers
It makes no sense to sell to someone who is a credit risk.
When they do not pay, you have lost more than the receivable.
As I have written about before, you lose the entire Gross Profit on that sale.
A bad debt of $1,000 is not $1,000. Take that and divide by your Gross Profit %.
$1,000/30% = $3,333.33.
To understand the philosophy behind this, please read this blog:
Top 7 Mistakes People Make in Managing Their Accounts Receivable
Way #6 – Take a Wee Bit Longer to Pay Your Payables
If you can, pay a wee bit more slowly.
Big companies and the government are notoriously slow payers to their vendors.
Develop a policy. Too many businesses just pay, well, whenever. The “whenever” is when a vendor screams loudly!
By all means, pay small vendors faster. For bigger ones, certainly pay a couple of days before due. Not sooner. BC Hydro will not need your money early. Pay it close to the due date.
Doing the above 6 things will lower (remember less is more) your cash conversion cycle.
Thanks for reading…