It used to be easier. When my best friend opened her very first lemonade stand, she did not have to use her allowance to purchase the lemons. Or the sugar. Or the paper cups. Or the table. Or the paper and magic markers for the “25 cents” sign. Or….well, you get the picture.
Fast-forward (more than) a few years. Imagine that we are running a lemonade company. Without our parents giving us our materials, we need to get suppliers for our raw materials (lemons, sugar), finance the production resources (labor and machines to squeeze and mix and package) and the inventory carrying costs, until we can sell our finished drink and collect our revenues from our customers – either direct customers (who, incidentally, love our lemonade), or distributors and supermarket chains (who love our end customers).
The cash-to-cash cycle determines how long we can walk the tightrope of having enough lemons to make lemonade. +The cash-to-cash conversion cycle calculation is: # of days to collect receivables from customers <plus> # of days inventory is kept in stock <minus> # of days to pay suppliers. The smaller that number, the better. +That means if we keep our lemonade in stock for 5 days, pay our suppliers in 30, and receive revenues from our customers in 45, our cash-to-cash cycle measures 45 + 5 – 30 = 20.
There are several factors that go into each of these elements of the equation; each of the Key Performance Indicators, or KPIs, must be managed to accomplish the ultimate goal of reducing the cash-to-cash cycle time, and optimizing cash flow.
- Accounts payable: You need to pay your suppliers. KPIs to consider include late payments, which typically incur a penalty and sour the relationship; invoice error rates when entering a vendor invoice, to improve the efficiency of the process; and late payments, which typically incurs not only mistrust, but penalties.
- Operations management: Once you have manufactured your product, you need to get it into the hands of customers. Critical KPIs include finished goods inventory carrying costs; finished goods write-offs, which could be due to quality issues or overproduction – or obsolescence if the lemonade is no longer fresh; the cycle time between receiving an order and shipping it; order fill accuracy, where errors will delay invoicing; and the cycle time between shipping a product and invoicing for it.
- Billing and collections: You need your customers to pay you. Key KPIs that influence your receivables include the error rate in bills sent out, delaying an accurate bill that should be paid; overdue receivables; invoice short pays by your customers; time to resolve customer disputes with invoices; and write-offs for uncollectible receivable balances.
There are many best practices that have been put in place by high-performing companies, including automation to reduce errors; centralized systems to reduce duplication; real-time communication with suppliers and customers; and integration of systems and collaboration between departments to ensure that sales forecasts and production plans are in sync. For the specifics, take a look at the cash-to-cash benchmarking survey, developed by SAP Value Engineering together with ASUG , the American SAP Users Group.
The smaller the number of your cash-to-cash cycle, the better. Still, managing your cash does not mean putting long-standing business relationships at risk. You do not want to be the company that goes to the extreme of consistently squeezing your suppliers or your customers. Put a solid strategy in place to manage your cash as well as your relationships – and save the squeezing tactics for those lemons.