Effective Policies and Procedures: The Complete Cash to Cash Cycle

Final in Cash to Cash Cycle Series

In the past four weeks, we’ve brought to light four key areas in which you can save $250,000 each — for a total of $1,000,000. Point by point, we’ve shown you just how cash flows through these areas, making up the Cash to Cash Cycle.

And as we’ve seen, the cash cycle is undoubtedly the single most important process to optimize for any business – from when you spend money to when you get money.

So now let’s put it all together.

Cash to Cash Cycle Definition

By definition, the cash to cash cycle is a financial ratio that shows the length time for which a company must finance its own inventory. It measures the number of days between the initial cash outflow (when the company pays its suppliers) to the subsequent cash inflow (Accounts Receivable).

Cash Conversion Cycle and Cash Flows

One way to express this is the length of time between the purchase of Inventory (raw materials, etc) and the collection of accounts Receivable created from the sale of your product — also called the cash conversion cycle.

Why is this most important? Because this is your cash flow and because;

Operations Assessment and Working Capital

Businesses live and die by the cash generated from operations. If your operations don’t create cash, then they consume it. A cash-consuming operation means that you have negative cash flow and you are living on financing (debt or equity). But the Cash to Cash Cycle also shows you the amount of working capital you have committed to your organization.

Just add the number of days of inventory to the number of days of receivables outstanding, and then subtract the number of days of payables outstanding. The result is the number of days of working capital your organization has tied up in managing your supply chain. This can be quite a significant number – one not to overlook.

This can also be expressed by the formula: stock days plus debtor days minus creditor days equals the cash-to-cash cycle.

So, for example, a company that keeps its stock for on average 30 days, gets paid by its debtors on average within 30 days and pays its creditors on average within 30 days will have a cash-to-cash cycle of 30 days.

Companies that receive cash from their customers at the point of sale and that have their inventory under good control will have a short cash-to-cash cycle. A company could even have either a negative cycle or a cycle time of zero. For example, if a business’ receivables and payables are held in check at 30 days while inventory runs at Just-In-Time (JIT) levels, then the cash cycle is zero – meaning that this company is in good shape with no working capital needs. And, of course, when receivable days are less than payables with JIT inventory, then the company will enjoy a positive cash-to-cash cycle – creating more cash on hand.

On the other hand, however, if a company puts payables down to 15 days and allows receivables to grow to 45 days, while inventory remains at steady levels, the cash cycle will be high. And. here, working capital will be constrained to compensate for inefficiencies.

Processes and Procedures Investments

Did you realize that working capital is the investment you are making in the inefficiencies of your processes and procedures plus your investment in your suppliers’ and your customers’ inefficiencies too? In other words, if you do not monitor inventory, accounts receivable, sales and marketing and accounts payable to ensure a healthy cash-to-cash cycle, then your working capital needs will not maintain a strong cash flow. The process will be out of control, and will not be optimized to create the greatest amount of financial effectiveness for the company.

Policies and Procedures Savings

So now you can see the relationship between your cash flow, your working capital and your cash to cash cycle. In order to increase your cash flow, you need to increase the velocity of your cash to cash cycle by reducing the inefficiencies found in your processes, your suppliers’ processes and your customers’ processes. The result is a decrease in your working capital and an increase in your cash. And, as we’ve seen, this can be a significant number – again, one that you shouldn’t overlook.

Part One: Inventory
Part Two: Accounts Receivable
Part Three: Sales and Marketing
Part Four: Accounts Payable

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Posted on Monday, January 31st, 2005 under Accounting & Internal Control, Accounting Procedures Manuals, Financial Policies

Licensed under a Creative Commons Attribution 3.0 United States License.

Originally published by Bizmanualz, Inc. under the title Effective Policies and Procedures: The Complete Cash to Cash Cycle.

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