Growth is expensive!
Most people don’t realise how much cash growth sucks up, even when profitable.
90% of Startups fail. 82% of those that failed were due to cash flow problems
Most owners think that as long as their business is profitable, they will have more money by adding more sales and scaling.
If only business were that simple.
Yes, if your product/service remains profitable as you scale*, you may end up with more profit - but this is very different to cash! Chances are, as you scale, you will end up with LESS cash, not more.
This is never more true than those holding stock and selling physical products. It’s one reason why so many eCommerce scaleups bring in outside investors.
Understanding your Cash Conversion Cycle (CCC) is key to managing your cash flow.
*Just because you are profitable now doesn’t mean you necessarily will be as you scale. It’s easy to let margins slip and find it more expensive to acquire new customers as you grow.
Calculating Your Cash Conversion Cycle (CCC)
The Cash Conversion Cycle shows how long it takes to convert the investment in your stock into cash from sales.
Simplistically, the shorter this time, the better, as less cash is tied up in stock as you grow.
CCC = Average Stockholding Days + Average Receivable Days - Average Payable Days
Average Stockholding Days
Shows the average number of days you hold stock before selling it.
= Average Stock / Cost of Goods Sold (COGS) * 365
You can change 365 to match the period you are measuring. 30 if monthly, for example.
Average Receivable Days
Shows the average number of days for clients to pay you.
= Average Accounts Receivable / Sales * 365
Average Payable days
Shows the average number of days it takes you to pay your supplier’s bills
= Average Accounts Payable / COGS * 365
The CCC calculation itself is simple. Word of warning, though, as always with financial metrics, ensure you have clean data and well-prepared management accounts (including period-end adjustments) before plugging the numbers into the formulas above.
What Does It All Mean?
It’s all well and good calculating your CCC, but you have to understand what it means and what you can do with that information.
In short, it shows how long cash is tied up in your business. The shorter the period, the better.
Some businesses have a negative CCC. Amazon and GymShark are two famous examples. A negative CCC means they collect money from their customers and sales BEFORE paying it to suppliers. This is the dream! It means that your suppliers and customers are actually funding your growth. The quicker you grow, the more cash you generate to reinvest.
Most businesses don’t manage this, though, so it’s all about doing what you can to shave as many days off your CCC as possible.
In the below example, reducing the CCC by 7 days generated an additional £50k in cash!
| Sales | £1,500,000 |
| Cost of Goods Sold | £955,000 |
| Overheads | £220,000 |
| Accounts Receivable | £210,000 |
| Inventory | £160,000 |
| Accounts Payable | £95,000 |
Cash Cycle = 76 days |
|
Debtor days reduced by 9
+
Inventory days reduced by 6
=
Increased cash: £52,685
Ways To Improve Your Cash Conversion Cycle
Here are some ways you can improve your efficiency and shorter that CCC:
-
Reduce Stock holding - invest in better systems and data to reduce the need to hold so much stock
-
Find ways to speed up customer payments - preferably to the point they pay before you pay suppliers! Negotiate short credit terms on sales and have a kick-arse credit control process in place. Remember, any credit you extend to your customers (intentionally or not) is effectively an interest-free loan!
-
Longer Supplier payment terms - if you can’t negotiate longer terms, look at financing options to delay payments until after you collect cash.
Other Industries
Whilst the Cash Conversion Cycle has essentially been developed for those businesses who hold stock, the basic principles are the same (and just as important) for most other sectors too.
If you are a service provider, you can replace the stock with Work In Progress, and the above applies just the same.
Truly understanding the difference and the relationship between profit and cash is key to mastering successful growth. Use the Cash Conversion Cycle to help you monitor your cash management's effectiveness and get to grips with how much additional cash you will need in advance to fund your growth journey.
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.