The cash conversion cycle (CCC) is an essential metric for businesses who depend on inventory management and related operations. It measures how many days a company takes to convert their raw materials into cash flow from sales, and takes into consideration the payment terms to avoid sustaining penalties. Additionally, CCC helps businesses evaluate their operational and management efficiency. During times of crises (like the current coronavirus pandemic) it’s vital that companies examine their CCC and make adjustments to keep their cash flowing.
The basics of CCC
Also called the net operating cycle, a company’s CCC is a measure of how fast cash cycles through their operations. By adding the days inventory on hand (DIO) with the days receivables outstanding (DRO), and subtracting days payable outstanding (DPO), a company can determine how much cash they have available.
CCC = DIO + DSO – DPO
Understanding this metric will help companies improve their management of working capital and provide more cash and flexibility for their business.
Maintaining a low CCC is usually desirable for most businesses, but that task is loaded with uncertainties. There are many things that influence or disrupt the CCC. For example, consumer buying behavior, supply chain disruptions, or a pandemic.
COVID-19 has reduced consumer demand for many retailers, increasing the CCC and reducing cash reserves. However, for some, the pandemic has increased demand (e.g., toilet paper and sanitizer), leaving them without inventory to meet demand. Supply chain disruptions due to COVID-19 also can affect inventory levels. Unfortunately, many suppliers are facing the challenge of slow-paying customers as a result of increased CCC.
Dealing with CCC during COVID-19
When the CCC is disrupted due to a crisis, businesses must take necessary actions and precautions to ensure their CCC doesn’t get out of control. Here are a few tips to manage your CCC during these uncertain times.
- Implement price reductions and sales promotions to keep your inventory moving.
- Be flexible so you can adapt to changing conditions. For example, instead of maintaining a physical presence, implement delivery or drive-up services. You also may need to create an alternative or additional income stream.
- Negotiate payment terms with vendors.
- Update your credit policies to better manage risk, and work with slow-paying customers to maintain business relationships.
- Require a deposit for goods or services to keep cash coming in.
- Negotiate supplier payments to coincide with when you get paid.
- Send invoices as soon as products or services are shipped or completed. Follow up to ensure they received your invoice.
- Stay on top of collections.
- Be prepared to resume normal or alternative business operations once the crisis subsides.
It’s not only about you — know your suppliers’ CCC
Your business relies on cash flow. Cash flow depends on moving inventory. And your inventory relies on your suppliers. When one of those links is damaged, your cash flow is in jeopardy. Knowing your supply chain’s financial status and understanding their CCC helps you better assess your risk. You can mitigate risk by requiring financial transparency from suppliers and understanding their vulnerabilities. Imposing harsh commercial terms on suppliers — such as demanding 120-day payment terms — without understanding their financial challenges is not good business sense and can damage valuable supplier relationships.
During these uncertain times, a proactive CCC management strategy — including analyzing existing inventory, understanding your customers, and strengthening partnerships — can prepare a business for bouncing back after the current crisis subsides.