13d • General
Cash Conversion Cycle
How fast do you collect your receivables? How long do you take to settle your accounts payable?
In a service business, these are the two main drivers to the cash conversion cycle.
This is what creates "velocity" for your cash. Let's assume you collect your cash upfront (no receivable balance) and take 30 days to pay any suppliers for materials.
- Your cash conversion would be 0 - 30 = -30 days. HUH? You read that right. Your cash conversion cycle would allow you 30 days to generate cash before paying vendors.
Let's now compare this to a scenario where you grant 30 days of credit to customers and pay vendors upfront.
- Your cash conversion cycle would be 30 days - 0 days = 30 days. This means that your cash leaves your account before you collect your cash from the sale.
Scenario 1 allows you to grow significantly faster as the cash received upfront can be used to acquire more customers before having to pay vendors 30 days later.
Why would you care?
In a normal service business, the largest expenses is generally your payroll. Payroll is paid weekly or biweekly in most cases. That means that if it takes you 30 days to collect on sales, then you would have to cover 4 weeks of payroll before cash enters your account. And you wonder why your sales go up and yet there is no cash to show for it.
Stay Under Par,
Samuel
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Cash Conversion Cycle
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