The success of any business lies in how well is it’s cash management. To be able to ensure financial stability in any business, no matter what its scale is, it is important that a company keeps track of the cash that is flowing in and out. If a company does not pay attention to the inflow and outflow of its cash, it shall fail to meet its financial obligations.
Plus, it shall also not be able to plan ahead for payments. Proper financial planning and meeting the current payment obligations are two important aspects of maintaining stability in any business.
Treasurers and CFOs at a business organization are usually bestowed with the duty of handling cash i.e. cash management. They are responsible for the company’s cash management endeavors. Luckily enough, these people have a number of tools and software at their disposal that can help them to manage the company’s cash effectively. These tools and products have especially come in handy to the treasurers and CFOs during the pandemic. They have been able to go about their cash forecasting and optimization endeavors efficaciously. And as the pandemic enters its second year, more and more treasurers and CFOs are now scouring for more digital solutions to manage the influx and outflow of cash. Banks and financial institutions have also started using various tools and bank reconciliation software to stay put in their business and track the cash flow.
However, though there are a number of tools and products available in the market, it can, at times, become difficult to choose the right product. And to be able to make the right decisions, companies are now attending several webinars and participating in discussion panels hosted by experts and the leading lights in industries across several verticals.
Having said that, let us now move into analyzing the different components of the corporate cash cycle.
The Different Components of the Corporate Cash Cycle:
Broadly speaking, there are two main components of the corporate cash cycle- time and money. The component of money can further be divided into several other parts- the money required to buy and sell inventory, as well as the money required to store the same. Further, you also need money to collect on invoices after they are shipped and received. In simpler words, the cash cycle or the cash conversion cycle is the time a company takes to convert its investment in resources. It also includes the time that the company takes to convert its inventory into cash flows from different sales.
Another component that we need to discuss while talking about the corporate cash cycle is the working capital. Working capital, in its simplest terms, is the short-term assets sans the short-term liabilities. When we talk about assets, it involves accounts receivables, inventory, and cash on hand. Liabilities, on the other hand, include account payables. This is the money that the company owes to others. It is important that a company keeps a weather eye on its working capital so that its liabilities do not exceed its assets. If a company’s liabilities exceed its assets, it could have a hard time staying afloat.
There is a simple formula that can be used to calculate a company’s cash conversion cycle. However, before we look at the formula, it is important to look at the different parts of the formula and understand the same. Given below are a few definitions that could help one infer the formula of the cash conversion cycle.
DIO (Days of Inventory Outstanding)
DIO is the average number of days that a company takes to hold on to its inventory before it finally considers selling them out. This is the company’s inflows.
DSO (Days of Sales Outstanding)
DSO is the average number of days that a company takes to collect payment from a sale that has been made. This is also the company’s cash inflows.
DPO (Days Payables Outstanding)
The final part of the formula is the DPO which is the ratio that gauges the average number of days it takes for a company to clear off its bills. This is the company’s outflows.
Hence, let us finally look at the formula.
CCC = DIO + DSO – DPO
Calculating the cash conversion cycle is imperative for the growth of any business. Once a company is able to successfully track its cash conversion cycle, it can work out and understand its working capital and make better and informed decisions regarding cash management. The cash conversion cycle also helps the company to better understand its competitors from the same field.
As mentioned earlier, tracking the cash flow is imperative for a company to understand its finances. Hence it is important to use products and tools that shall help a company to understand its cash flow. Make wise decisions in the future regarding the same. Finding the right cash management solutions is imperative for the growth of any business, and this shall only be possible when a company successfully tracks its cash flows.