Mastering the Cash Conversion Cycle: Tips and Tools for Success

Mastering the Cash Conversion Cycle: Tips and Tools for Success

Authors:
Carrie Zoucha, Vice President, Commercial Payments-Centime Business Strategy
BC Krishna, Founder and CEO, Centime

A critical factor influencing business profitability is the cash conversion cycle (CCC). A slow CCC can significantly hinder profitable outcomes by tying up capital and resources. For example, when a company takes longer to convert accounts receivables into cash, it may struggle to meet immediate financial obligations, such as paying suppliers or covering operational expenses. 

Less cash on hand can lead to increased costs through borrowing and interest payments, as businesses seek cash to stay afloat. Moreover, a protracted cash conversion cycle limits a company's ability to reinvest funds into growth opportunities, further eroding the bottom line. In essence, a sluggish cash conversion cycle can not only restrict a company's financial flexibility but also diminish its overall potential for profitability.

Fortunately, there are steps your business can take to improve days sales outstanding (DSO) and days payable outstanding (DPO), two critical metrics when it comes to managing liquidity and expediting your cash conversion cycle.

Strategies to Reduce Days Sales Outstanding and Enhance Cash Flow

Days sales outstanding measures the average amount of time it takes for your customers to pay after sending them an invoice. In general, businesses that collect payments faster have a low DSO, while those with longer payment cycles have a high DSO.

A low DSO sets your business up with better cash flow, making it easier to cover operational expenses and invest in growth opportunities. Conversely, a high DSO results in lower cash flow, putting pressure on margins as well as the bottom line because your company may need to borrow funds or use its own capital to maintain operations.

However, you may be able to reduce days sales outstanding by following a few simple tips:

Tip #1: Regularly review customer credit profiles and ensure you set clear credit policies and limits. This monitoring lets you know when you need to take action, such as requiring stricter payment terms or requesting upfront payments from customers who fail to pay on time. Assessing new customers with the same rigor and applying the appropriate credit terms upfront can help you avoid risky transactions altogether.

Tip #2: Offer incentives for early payments and enforce strict collection procedures. Early payment incentives motivate customers to settle invoices promptly, injecting cash back into your  

company sooner and more regularly. Late payment fees and other consequences can act as deterrents by creating a sense of urgency and providing a sense of accountability for customers to follow payment terms. This in turn often reduces DSO and ensures better financial stability.

Maximizing Profitability by Extending DPO

Days payable outstanding is a ratio that measures the average time it takes your company to pay your supplier invoices. Achieving a high DPO indicates longer payment cycles and a more efficient use of resources, allowing your company to preserve working capital and enhance liquidity.

While it is important to pay bills on time, there are legitimate ways to extend billing cycles and get the most use from your funds:

Tip #1: Develop mutually beneficial relationships with key suppliers to negotiate longer payment terms and discounts. Suppliers may be more willing to accommodate longer payment terms when they perceive a partnership built on trust and reliability. Extending terms allows your company to hold onto its cash longer, effectively expanding DPO.

Tip #2: Take advantage of early payment discounts when feasible to reduce costs.

While the goal is to extend DPO, negotiating longer payment cycles is not always possible. However, vendors may be willing to offer early payment discounts. Capitalizing on early payment terms can translate into significant cost savings over time. Balancing longer payment terms with an occasional early payment discount can help optimize your working capital.

Harnessing Technology for Enhanced Cash Conversion Cycle Management

The tips above are critical to not only managing but also optimizing your cash conversion cycle. However, gaining this state of financial efficiency isn’t always easy given the moving pieces in play.

This is where accounts payable software, like Centime, offer tremendous benefits by automating

payment functions and delivering key insights to optimize your cash conversion cycle. 

For example, modern AP automation technology can efficiently track customer invoices and send reminders before they are overdue, minimizing your risk of late payment fees to lower DSO. Furthermore, efficient payment processing allows companies to make their own payments closer to the due dates to extend DPO without incurring penalties.

In addition, a robust cash forecasting platform can provide finance teams with improved cash flow predictions and insights to help optimize the cash conversion cycle and make informed financial decisions.

Learn more about the tools that support cash management.

About the Authors

Carrie has over 20 years of banking and payments industry experience. In her current role, she has the opportunity to work with large corporate clients. She enjoys learning about their business and helping them grow by providing a range of solutions, including commercial card and corporate treasury services.

A seasoned and successful entrepreneur, BC is passionate about solving large, long-standing problems through the innovative application of technology. He is the Founder and CEO of Centime, where he is on a mission to help small-to-medium sized businesses thrive by giving them the tools to manage cash and optimize working capital.