For all of us non-financial professionals out there – and we are many! -, meetings with the CFO and other finance-literate colleagues sometimes feel like watching a movie in Inuktitut*, without knowing a word of the language.
The business finance world is abundant in terminology that does sound threatening to the untrained eye. Our purpose here is to explore the meander of this foreign territory with you, so you can impress your peers in your next meeting… and contribute more actively.
Today’s pick is the cash flow rotation, also known as the cash conversion cycle, a.k.a CCC.
Simply put, the CCC measures how quickly an organization turns their investments into cash.
Before our neurons heat up, let’s use a concrete example! Imagine you want to sell waffles to fund your kids’ school trip to the Kerguelen Islands.
You spend money for the ingredients, the table, and the tray to display your delicious products, for a total of €50. And you earn money from selling the waffles, for a total of €100. The cash conversion cycle is the time you take to buy the material and ingredients, bake the waffles, sell them, and collect the payments.
In other words, it is the time it takes for you to recover the €50 you invested (plus the €50 profit).
The faster you recover those €50 invested at start, the faster you can buy ingredients again, the faster you can bake another tray, and the faster you can sell them and make a profit.
Do you see the limitation?
If you don’t have external investors, you depend on recovering those €50 to further invest in your waffle business, pay back debts – from last year’s lemonade stand – and more. If you don’t recover your initial investment fast enough, you cannot grow or invest further.
It can also get tricky: if the table you rented needs to be paid before you collect the payment, but you have no cash available… well, your waffle business might come to a sudden stop.
So, the cash conversion cycle is a fundamental metric to assess how efficiently your business manages the money coming in and out, the cash flow.
It can be accelerated by:
- reducing the amount of inventory waiting to be sold (the waffles on the tray)
- collecting payments sooner (although Mrs. Dujardin promised to pay for the waffles in two months, an immediate payment would provide you with the needed cash to scale up your business to all schools in the surroundings, or invest in cookie-baking).
- increasing payment terms to suppliers (the supermarket can wait a bit more until you pay for that flour, you might end up creating jobs, after all!)
So, looking at your own business, what do you think your cash conversion cycle looks like? Is it rather short? Rather long? Can you improve it? And if you did, how would you use that freed up cash?
*One of the principal Inuit languages of Canada, spoken by 38,000 people as per the 2021 census.