All business want to increase sales, profit and cash, but sometimes increasing sales doesn’t seem to lead to more profit or cash. This may have something to do with the time it takes convert leads into cash. This is commonly referred to as the Cash Conversion Cycle (CCC). It is formally defined as resources into cash. That is, CCC=DIO+DSO-DPO where DIO is the days inventory outstanding, DSO is the days sales outstanding and DPO is the days payables are outstanding.
There is a challenge with calculating CCC for companies that carry very little inventory (Lean) or are services based…DIO goes to almost zero. Additionally, there is typically significant resource investment in the sales process. What becomes valuable in these cases is to understand the duration of our sales cycle (SC). To further make CCC useful for these companies we can break DSO into two parts (so we can see if we are improving), Days Work Outstanding (DWO) and Days Receivables Outstanding(DRO). Days Work Outstanding looks at the time it actually takes to finish the work purchased by a client. How long from the sale closes to when we can bill? Days Receivables Outstanding (DRO) looks at the average age of our receivables.
So if we assume that DIO is zero, and SC, DWO and DRO are greater than zero, we can rewrite CCC to be:
CCC=SC+DWO+DRO-DPO
This lets us have a better look at the time it takes to go from lead to cash. We want CCC to be as small a number as possible…that is we want SC,DWO and DRO to be small and DPO to be large. Here are some simple strategies to achieve this.
- Shorten Sales Cycle. Is your sales team focuses on selling or are they spending time enter data into expense reports, doing quotes or attending meetings? What can you do to keep the sales rep focused on selling activities?
- Reduce Handoff Lags. How long does it take for the sales team to notify operations that work can begin? How long does it take once the work is complete for an invoice to be sent? What can be done to shorten or eliminate these lags?
- Keep on Top of Receivables. Will your clients accept Net 15? Who is calling an checking on aging receivables? What percentage of receivables are late?
- Pay vendors later. While this is going to increase liabilities on your balance sheet, it will free up some cash in the short term. Be careful here! Negotiate these terms and pay on time. Damaging your credit reputation can have other negative impacts on your business.
