Riding the Waves of Liquidity
It is a volatile marketplace indeed. Any entrepreneur maneuvering on the waves in this current environment is surely getting a wild ride. For the savvy entrepreneur, these stormy conditions offer advantages of opportunity if they can survive the tumult. Some even see opportunity to expand, taking advantage of supply and demand shifts as fellow entrepreneurs fail to effectively bail themselves out and are forced to abandon their sinking ships. And although profits are generally the focal point of any business, current conditions may dictate a more concentrated focus on your liquidity. That means finding the most effective balance within your Cash Conversion Cycle (CCC).
You can hear the snap of the leather, as every business belt is tightening. Lending institutions are cracking down on their extensions of credit, demanding more collateral, tightening up on their lending windows and increasing the cost of extending credit just to name a few. Some entrepreneurs are finding that at one time they had pre-approved credit line, but now may not. (It is recommended that you check and make sure that this is not you!) For more in depth information on Cash Conversion Cycles and how it is calculated google “Invesrotpedia” or “Wikipedia.” Both sites have clear and concise definitions, working models and calculations to help you get a good start in understanding and implementing effective CCC plan for your enterprise.
In it’s simplest terms, the cycle refers to the number of days between when a business pays for it’s materials/ inventory, and receives cash for these goods. It represents the time in which working capital is “tied up”. If you can shorten the CCC, the need for external financing and the resulting interest expense will be smaller, thus creating higher profits. Although each business is unique, you are aiming at reducing this number as low as you can. It will require discipline, setting of targets and continual effective monitoring. Ultimately the goal is to find a balance in three areas: the payables, the receivables and inventory management.
You will be looking for strategies that will increase the days of payable outstanding, effectively slowing down the cash going out the door. You can negotiate with your vendors but be careful here, the downside is alienating them and jeopardizing your relationship. Other considerations on extending the period of payment due on the payables side of the cycle might be looking at weighing the cost of accepting a trade credit discount for early payment as opposed to the benefits of using your cash elsewhere. It may also be suitable for you to set up a zero balance account where funds can be automatically transferred by the bank when they are needed for clearance of cheques.
Next your focus will turn to inventory control; the software on the market available for inventory control is huge. Regardless of of your enterprises make up, size, or needs there has simply got to be a cost effective product that is a perfect fit for you. Do your research! But by all means do not let inventory control be a guessing game. It can be the key link between success or overwhelming red ink. With the right information accumulated from a good inventory analysis program you can identify and deal with your worst night mares like: dead and slow moving stock, and over orders. Then you can clearly see and implement control strategies that will minimize stock on hand, while keeping your customers happy and your business running.
Your final step in tightening up your cash conversion cycle will be to look at your receivables. Calculate and evaluate your average collection period. As a rule of thumb, if the average collection period is one third larger than the credit period extended on the statement, there may be a problem.( For example on average it took you 40 days to collect on invoices with a 30 day net.) Age your receivables to identify and actively pursue slow paying customers and attempt to lessen credit risk by tightening payment terms to "net 15", or by actually selling fewer products on credit to the high risk accounts, or even cutting off credit entirely, and demanding payment in advance. Establish a discount percent for early payment, and a surcharge for late payment. Identify and evaluate accelerating payment techniques for collecting such as pre-authorized cheques, or direct deposit transactions. And finally, the use of a collection agency is not really a tool to manage credit risk; rather, it is an extreme measure because you can expect a below-agreed return after the collection agency takes its share (if it is able to get anything at all).
An efficient CCC will translate in a tightly run ship, with a more profitable bottom line. Cash is king in this environment and a well balance cash conversion cycle will enable you to access the best financial arrangements for your situation if the need arises. You will have a better chance of holding on to your pre-approved credit line, or fitting into those tighter lending windows. And you need what ever advantage you can get now days.
