In the 1990s, Michael Dell re-engineered Dell Computer’s distribution model. It went from a sell-from-inventory system to a build-to-order system. The switch catapulted the company to the top of its industry and revolutionized Dell’s cash and profit picture as well. Over a period of four years, Dell’s revenue went from $2 billion to $16 billion and by 1998 the company had $1.8 billion in cash. How did they do it?
They first looked at their Cash Conversion Cycle.
The Cash Conversion Cycle (CCC), also called the Net Operating Cycle, is the number of days between disbursing cash and receiving cash. So it measures how long it takes your business to:
- Create your goods and services
- Deliver your goods and services
- And get paid for those goods and services
Think of it like an old wristwatch. It has 3 separate gears each moving at a different speed yet working together to control the hour, minute, and the second hand functions. If any of one of them gets out of sync, you don’t get an accurate time. Likewise, any change in creating, delivering, and getting paid for your goods and services can throw your entire operating cycle out of whack.
Tracking your Cash Conversion Cycle allows you to measure performance as well as forecast cash. It’s also an excellent early warning system because it lets you know if all your cycles are aligned, and can alert you when one is off or has changed.
How to do it — a three-step process:
- Identify the hand-off points in the creation, fulfillment, and payment of your goods or services.
- Clock it. How long does it take to create and deliver your products and services? Add your Receivable cycle then subtract your Payable cycle. That gives you your starting number. If your business is seasonal, then you’ll want to have separate on- and off-season numbers.
- Analyze each process and the steps that make it up. Mark the originating points and the termination points. It’s really not as complicated as it sounds. You can use our Cash Conversion Cycle Worksheet to make it even easier for you.
Measure it, then manage it
Once you know your cycle, you can maximize it to have better cash management and to increase your cash and profitability.
Here’s another example of how this can have a huge impact on your bottom line. There’s a large legal firm that generally has to file several motions or appeals before winning an award and collecting fees. With each decision, they have 15 to 30 days to submit their filing. The paralegals involved usually calendared the deadline on the day before it was due. By moving the deadline sooner — 72 hours from decision received date — they literally shaved months off their Cash Conversion Cycle.
It is important to understand that not every component of the cycle can be or should be accelerated. First look at what is optimal and realistic. Then look at what can be improved. Just as you would not want your baby born much sooner than nine months, you don’t want to speed up certain cycles if it could lead to disastrous consequences.
Managing your CCC can have tremendous impact on both your cash and operations. This is not an outward-focused measurement. Those, like industry benchmarking, are important to be sure. However, creativity doesn’t come from comparing yourself to competitors. It comes from an intimate knowledge of your customers, suppliers, and processes — the management of people, time, and money.