Want to Boost Your Bottom Line? Shorten Your Cash Conversion Cycle

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Finance Insights for ProfessionalsThe latest thought leadership for Finance pros

Thursday, November 4, 2021

Every business wants a smooth and steady cash flow. Here's how you can make progress towards that goal by optimizing your cash conversion cycle.

Article 4 Minutes
Want to Boost Your Bottom Line? Shorten Your Cash Conversion Cycle

Your cash conversion cycle - the amount of time it takes for the business to turn investments in inventory and resources into incoming cash flow from sales - is a critical element in your financial performance and commercial success.

It shows you how long the money you spend is tied up in processes such as production and sales before being converted into cash received. The cash cycle is reflective of the time you have available or need to dedicate to tasks such as:

The quicker you can convert cash spent into payments received, the better, so you should always be looking for ways to shorten this cycle. Here are five ways you can do it:

1. Optimize your inventory

One of the biggest threats to a quick and efficient cash conversion cycle is poorly managed inventory. A common pitfall that all companies should take care to avoid is cash being tied up in assets that are of no immediate value.

For example, you don't want large amounts of merchandise to accumulate in a warehouse and eventually go unused. However, you also need to be sure you have enough raw materials and inventory available to satisfy demand from customers and make sales.

So how do you strike this balance? One of your top priorities should be to study, monitor and predict customer demand, so you can make informed predictions about the amount of stock you need and when you're likely to need it.

There are various ways to go about this. Working closely with the marketing department, for instance, will help you understand where the company is focusing its promotional efforts and where demand could increase as a result.

Tactics like social listening can also help you track trends and sentiment in your audience, which will inform your thinking about what your customers want and need right now.

2. Work on your customer relationships

Building positive and healthy relationships with your customers raises the likelihood that you will receive punctual payment for the products or services you've supplied. This, in turn, optimizes your cash conversion cycle because you can make more confident predictions about when the business will have money coming in from sales.

The ability to cultivate strong, lasting connections with clients will also help you retain those that are the most punctual and reliable payers, thereby shoring up your cash flow for the future.

Positive actions that contribute to better customer experiences include:

  • Following a consistent onboarding process that starts every relationship on the right foot
  • Being proactive and working to address client needs and problems in advance
  • Implementing structured communication plans that ensure you stay in touch and maintain a healthy dialogue with your customers

3. Prioritize efficient invoicing

A smooth, consistent and efficient invoicing process will help you optimize your cash cycle by raising the likelihood of payments coming in on time.

There are a number of actions you can take to improve this aspect of your finance function, such as following a strict workflow to ensure every invoice is clear and detailed, keeping an electronic paper trail and reminding clients of upcoming payment deadlines.

You can also consider more specific measures that will aid faster collection of what you're owed. If you suspect certain elements of an invoice will be disputed - for example, unusual fees or reimbursement for expenses - you could bill these separately from regular deliverables, to ensure these minor quibbles don't hold up the entire process.

4. Crack down on late payments

Good customer relationships and efficient processes increase the likelihood of you being paid on time, but the unfortunate reality is that you won't always receive what you're owed by the date specified on your invoices.

If this starts to become a serious hindrance to your performance, consider taking steps to clamp down on poor payers and incentivize timely settlement, such as:

  • Charging interest on late payments
  • Making it clear that you will pursue debt recovery action if necessary
  • Offering discounts for early payment

You should also do your research on new clients to evaluate their credit risk and to see if they have a history of paying their suppliers and creditors late.

5. Look for flexibility in accounts payable

Receivables are a crucial element of your financial performance, of course, but they're only one side of the cash conversion cycle.

To truly optimize this aspect of your business, you should also be thinking about your accounts payable. If you're able to negotiate a degree of flexibility in your payables - for example, by arranging 45-day rather than 30-day payment schedules - you'll benefit from some breathing room in your cash cycle and give yourself more time to collect your receivables.

Much like your customer relationships, it's important to focus on nurturing and maintaining your associations with vendors, suppliers and creditors. Establishing trust and building a track record for reliable payments will help you make your case for more flexible terms, which will make a big difference to your cash conversion cycle in the long run.

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