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Harvard Business Review found that startups that improve their CCC by just 10 days can increase their cash flow by up to 20%. According to a study by CB Insights, startups with a shorter CCC are more likely to succeed. The study found that startups with a CCC of 30 days or less are twice as likely to be successful as startups with a CCC of 60 days or more.
Cash Conversion Cycle (CCC) is a financial metric measuring the days a company takes to convert its cash into inventory, sell it, and collect the cash from customers. It is a measure of how efficiently a company is managing its working capital.
Working capital is the difference between a company's assets (cash, inventory, and accounts receivable) and current liabilities (accounts payable and wages payable). A company must have enough working capital to meet its short-term obligations and fund its operations.
A shorter CCC is typically better, as it means the company can convert its cash into sales and collect the cash from customers more quickly. This frees up the company's cash for other purposes, such as investing in growth or paying down debt.
Now, you can think. Yeah, I get it, but this is some finance stuff that the CFO should handle. Well, that's in their realm of responsibility, but the problem is a bit broader if we look at it from the perspective of your entire company. The metric is one of the few that tell you if you are converting your company's operations into a cash machine. It might not be there yet, but by understanding the levers, you create a particular culture around that. And guess what? Your investors would love to know whether you are thinking about that or not or whether you know what to do with your business to get there. Imagine you changed the seats for a moment what would you want to know from the company assuming you gave them millions of dollars? Exactly. You would ask your company how they manage their cash collection because it indicates your ROI and a path to get there. Another aspect of working between different departments is to be financially savvy (and you can only expect them to be if that's their background). However, understanding these principles can help you guide your mid-level managers to make better decisions that will eventually improve your 3C. Let's say your sales rep comes to you and tells you that they have a custom deal that has two or three variants, giving you some advantages or disadvantages in collecting more cash in the short term for other benefits that the prospect would receive in the long run. Yes, that will depend on your financial situation, but assuming you are in the bearish market, you want to get your money faster (I know many nuances are missing here). The rep recommended collecting money faster, saying that we needed it now to improve our liquidity situation because she talked to their direct manager, which made her (or him) aware that this was the best deal for the company. Assuming she hits her targets, I can tell you that you want to keep that rep in your company. Another example could be from the marketing department that is about to purchase a new system (any). If they can negotiate to pay for the new miraculous system with monthly payments instead of upfront, that's what you want to see. OK, so what is the metric about? Below is some explanation of how to calculate that:
Calculation: CCC = DIO + DSO - DPO
More gibberish for the unaware here:
DIO = Days Inventory Outstanding: The number of days a company takes to sell its inventory.
DSO = Days Sales Outstanding: The number of days a company takes to collect customer cash.
DPO = Days Payable Outstanding: The number of days a company has to pay its suppliers.
Now. This is what you need to know about this. Your CCC is reasonable with less than 30 days. A CCC of 30-60 days is average, and a CCC of more than 60 days may indicate that the company needs to manage its working capital more efficiently. These are general rules but might vary depending on the industry. Good benchmark, in any case.
Keep in mind that retail companies tend to have shorter 3Cs than companies in the manufacturing industry. Retail companies typically have faster inventory turnover and shorter collection periods. We can all imagine why after the visit to Nordstrom.
Conclusion: If you are a department leader in a startup company, your responsibilities go far beyond what your job description tells you. Operating on what we know well is much easier than exploring new company performance areas. So-called silo thinking atomizes the company's resources and de-synergizes the cost, often lowering productivity. As an operational and financial leader, you need help sharing data or insight with your organization. Often, leaders in this area decide to keep sufficient information private from their teams or even leaders. Sometimes, it's a pragmatic approach to confidentiality, but often, it's just a resistance to share anything that comes at a higher cost over the years. Let's be honest. Creating a finance-savvy culture is a challenging task. It may be impossible outside of the financial services industry-based company. But it's much more work to manage an organization that needs to understand or rationalize the decisions made at the top, where individuals might be unaware of what matters at the end of the day.
There are several things that multifunctional leaders can or should demand to do to improve their CCC:
Reduce Inventory Levels: Excessive inventory can lead to tied-up cash, increased carrying costs, and potential obsolescence risks. To manage the implementation well, you must utilize lean inventory techniques like Just-In-Time (JIT) or adopt forecasting tools to predict demand better, ensuring inventory aligns more accurately with real-time requirements. Remember, your analysts are your friends, even if they don't deliver good news.
Shorten Payment Terms from Customers: Longer credit periods to customers can strain a company’s cash flow and increase the risk of bad debts. Collect fast if you can. Implement dynamic discounting wherein customers get discounts for early payments. Automate your invoicing and payment solutions to accelerate the payment process. Regularly review and adjust discounting policies. If you don't have one, don't wait, create one as you know, this is a red flag.
Negotiate Longer Payment Terms with Suppliers: This is just the flip side of the item above. Longer credit terms with suppliers give businesses an extended period to manage and utilize their cash. Build strong relationships with suppliers to negotiate favorable terms. Consider bulk purchasing or long-term supply contracts to leverage better discount terms. This is your procurement strategy that must be somewhat defined here.
Improve the Efficiency of the Sales Process: A streamlined sales process ensures that goods and services translate into revenue faster. Adopt (not only buy) CRM and CLM systems to manage your contract terms favorably. Optimizing this process is often forgotten because reps tell you, "You take it or not." In the end, you can only sell below the margin if you agree this to be your acquisition strategy with your BOD). If you sell to enterprise prospects, recommend hiring a deal desk manager to optimize sales strategies and train the sales team on best practices. Ensure alignment between marketing and sales for better targeting due to that effort.
Accounts Receivable Collection Process: Delayed collections can strain operational finances, making it essential to hasten this process. Use automated reminders for payments, offer multiple convenient payment options, and regularly review the accounts receivable aging report to spot and address delayed collections early. Implement creative ways to collect money upfront from the smaller entities with a higher risk of insolvency.
Implement Clarity: Awareness of each component of the CCC – inventory, accounts receivable, and accounts payable days – equips businesses with crucial insights. This knowledge facilitates the pinpointing of bottlenecks or inefficiencies in the cycle. However, there is another dimension of the knowledge circulation on metrics like this one. Ensure your mid-level management receives a set of guidelines that can help you manage the metric. It shouldn't be just a list of bullet points but very likely a regular update on the metric and functional contribution. Yes, it's a bit of work, but it's worth it if you know you are ahead of "tight" budgetary conversations.
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