What we need to measure is the length of time it takes to turn your investments in receivables, inventory, and work-in-process back into cash.
The length of your cash conversion cycle can be calculated using this formula:
Avg. inventory conversion period + Avg. receivable collection period – Avg. payable deferral period
Here's how you calculate each component of the formula:
- Average inventory conversion period = [(Avg. inventory + Work in process) /Cost of goods sold] x 365
- Average receivables = (Receivables/Sales) x 365
- Average payables = (Payables/Cost of goods sold) x 365
To increase profits, two other things need to be measured. First is the time it takes between first contact by a prospect and the time of the first order. The second is the time between receiving the order and when it is delivered.
Watch the video to see how your cash can be increased by improving your cash conversion cycle.