Improving the cash conversion cycle will lead to increased cash flow—unless you overdo it!
Business owners tend to overdo it in three common areas of the cash conversion cycle.
First, sometimes an owner will become so concerned about bad debts that they will impose extremely tough restrictions on granting credit. This can also be used to your advantage if one of your competitors has similarly tough credit terms.
When I was the CFO at our regional Coca-Cola bottling plant, I changed our terms so that any new business would automatically be granted credit. We obviously watched these new customers closely and quickly switched them to COD if they failed to pay. The result was that over 80 percent of new businesses offered only Coke products.
Second, inventory is sometimes reduced to the point that the company loses sales. This is particularly true for seasonal businesses.
Coca-Cola products are in high demand for holidays such as Christmas and the 4th of July. And customers want the product for the holiday not after it.
At Coca-Cola our production manager was told to keep inventories at a pre-determined level. Normally, this level was sufficient. But during the holidays it was common for the stores to run out of product. The customer would buy whatever was available and the sale was lost forever.
Third, the business owner continually delays paying vendors and operating expenses.
Taken to its extreme, this approach can result in loss of prompt payment discounts, bad credit, and quite often, higher prices.
So yes, improve your cash conversion cycle, but don't overdo it. Remember, pigs get fat but hogs get slaughtered. Don't be a hog. Use common sense to optimize your cash conversion cycle.