From the day you pay a supplier to the day the customer pays you, your money is on the move. This journey is called the cash cycle and is measured by a sum of additions and subtractions. Days that goods sit in inventory, plus days customers delay payment, minus days you delay payments to suppliers. The longer the cycle, the more cash you need just to stay afloat. The shorter it is, the more easily the business can breathe.
Verne Harnish, in Scaling Up, places the cash conversion cycle at the center of growth, because growth without sufficient cash is the fastest way to bring down a healthy business. The first ring is days of goods, the time inventory sits in the warehouse before it's sold. The second link is days sales outstanding, the time that passes from invoicing to customer payment. The third link is days payables outstanding, the only one that works in your favor, because every day of supplier credit is money your business retains. The cycle isn't shown on any standard report, so most owners aren't aware of it. But it determines how much cash is needed for each sales increase.
A small wholesale business sells 18,000,000 LEK per year, or about 50,000 LEK per day. Goods remain in stock for an average of 40 days. Customers pay on average in 35 days. Suppliers grant a 30-day credit term. The cash cycle comes out as 40 plus 35 minus 30, so 45 days. This means the business finances 45 days of sales out of its own pocket—about 45 times 50,000, or 2,250,000 LEK permanently tied up in inventory and unpaid invoices. Now suppose the owner shortens the collection period from 35 to 28 days, with clearer contracts and weekly follow-up. Seven fewer days at 50,000 LEK per day free up 350,000 LEK once and for all, with no additional sales, no credit, and no costs. With that money he pays two months' warehouse rent or reduces his overdraft along with its interest.
Harnish calls the power of one the most useful question in working capital. What happens to the money if each link improves by just one unit? One less day of inventory, in our example, frees up 50,000 LEK. One less day of receivables, another 50,000 LEK. One extra day of payment terms from the supplier, secured through negotiation rather than delay, another 50,000 LEK. A one percent higher price adds 180,000 LEK per year straight to profit. None of these moves requires new customers. They only require someone to measure and track them, and it is precisely here that your pyramid shifts from clarity to true control.
At the Resource Center you'll find the three-ring cash flow calculation format with the unit power table, where you can immediately see how much money each daily improvement in your specific business generates.
The standard formulas are as follows. Days of inventory, DIO, average inventory divided by cost of goods sold, multiplied by 365. Days sales outstanding, DSO, accounts receivable divided by sales, multiplied by 365. Days Payable Outstanding (DPO), accounts payable divided by purchases, multiplied by 365. Cash Conversion Cycle (CCC) equals DIO plus DSO minus DPO. In the full single-power model, according to Harnish and Alan Miltz, seven levers are tested—price, volume, cost of goods, operating expenses, and the three cycle components—each with a single unit, and they are ranked by their cash impact. For the trading client, it is particularly useful to compare the CCC with the actual average credit period from suppliers, because the gap between them is precisely the need for external financing. A negative CCC—when the client pays before the supplier is paid—turns the increase into a source of cash rather than a drain on it.
Yes, it's just that the first installment drops to zero or the work in process goes unfactured. For services, the cycle depends almost entirely on the collection days, so every day you gain there is immediately reflected in the accounts.
No unilateral delays, because you lose trust and often the favorable price. A long deadline must be openly requested in negotiations. A day gained by agreement is worth it; a day gained by delay costs you.
If you'd like us to calculate your business's cash cycle and together find the days that can be freed up, write to us at Contact page or see the packages at offer.
We take care of accounting and taxes, so you can save time, money, and focus on growing your business.
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