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  • Writer's pictureCaroline Brie

Improving Cash Conversion as A Finance Professional

During the course of the COVID-19 crisis, many companies have taken their eye off cash conversion. Instead, many companies continue to focus on cash issues, starting with trouble collecting from customers, which is likely a self-inflicted problem which holds back resources it needs to resolve. This is an unfortunate development in corporate finance. Companies that wish to thrive during these challenging times should understand the significance of cash conversion, how successful companies incorporate an effective cash conversion cycle, and what new resources are available in maximizing this use of this business quality barometer.

Defining Cash Conversion

The cash conversion cycle (CCC) is a metric which states the time in days it takes for a company to convert its investments in inventory and other resources into cash flows from sales. Also called Cash Cycle, CCC attempts to measure how long each net input dollar is tied up in the production and sales process before it gets converted into cash gained. This metric considers how much time the company needs to sell its inventory, how much time it takes to collect receivables, and how much time it has to pay bills.

The CCC is one of several quantitative measures that assess the efficiency of a company's operations and management. A trend of decreasing or steady CCC values over multiple periods is a positive sign while rising ones should lead to more investigation and analysis based on other factors. One should bear in mind that CCC applies only to select sectors dependent on inventory management and related operations.

Cash Conversion’s Significance

Cash conversion performance is a gauge for overall business quality. This is something all finance departments should keep in mind; in particular ones who claim that they have enough cash, or that interest rates are low, debt is cheap, and cash conversion is not a necessary focus. Generally speaking, companies in the upper quartile of working capital performance metrics relative to their peers have steadily improved their cash conversion rates, based on Ernest & Young LLP’s latest working capital management report. They often have a good flow of cash coming in, but continue to concentrate on advancements in things such as quote-to-cash to reduce bottom-line costs, and increase top line growth. Among the competitive edges of these model companies are effective and efficient cash conversion processes as part of a genuinely ingrained cash culture. The advantages of having and building cash on the balance sheet are as follows:

  1. The company can be agile in making acquisitions.

  2. The company is better able to take advantage of changes in the market.

  3. The company can pay down debt and be prepared to push through potential crises. A strong balance sheet can be a crucial safety net.

Hidden Costs in Cash Conversion

Consider the quote-to-cash process. Most organizations don’t understand that roughly two-thirds of the costs incurred to collect on invoices are hidden. This is caused by all the people touching steps in the process, which increases the likelihood of error. Sales support, billers collectors, and cash applicators are the tip of the iceberg. Well-paid sales reps may need to resolve inaccurate orders or chase down missing purchase order information instead of simply executing their traditional roles.

Cash can also get tied up in tax and legal support, third-party collection fees, software license fees, bank fees, and management support. All are prime examples of hidden costs tied up in the quote-to-cash process. In addition, errors increase costs significantly and create a poor customer experience, resulting in a drain on people, resources, and revenue.

The Place of Technology in Cash Conversion

Automation is one part of improving cash conversion, including opportunities to incorporate predictive analytics, robotic process automation, and software applications which improve accuracy, enhance productivity, and speed up efficiency. Improved processes and use of labor-saving digital capabilities not only improve cash flow and decrease the expense associated with the quote-to-cash cycle, but they can also have a significant impact on sales productivity.

Many CFOs today are attempting to instill a cash culture in their organizations. This begins with understanding the factors which positively or negatively affect the balance sheet. Then as companies grow, they concentrate on not just results, but how they attained those results. Certain questions need to be asked; Who had to be involved? How much does it cost to convert a dollar of cash? And, how could resources be better deployed?

However, while tools and software can eliminate human interaction, they never wholly replace people from tasks such as contracting and developing sales orders. Lost revenue may result from a culture where salespeople are not spending enough time selling, and the poor customer experience turns revenue away. It is not uncommon to find that salespeople spend less than 50% of their time on actual sales or proposal development. Sales reps are often asked to do far too many non-sales-related tasks, and this issue is often exacerbated by the fact that the reps are not provided with the tools and support to execute such unorthodox tasks.

How to Start Improving Cash Conversions

A great way to improve cash conversions is to process-map an invoice from the initial sales quote, through contracting and billing, collections, and finally to applied cash. You may be surprised at how many manual steps are involved and how frequently errors can occur. At each point, manual steps can become a potential point of failure that leads to slower revenue collection and increased rework. In addition, it has been found that the actual cost to invoice, including all labor and third-party fees, is often two to three times higher than most assume.

One common problem companies have is adhering to purchase order requirements. When bills are created for a customer, they often do not reference the purchase order. In such scenarios, customers refuse to pay without that reference. Some of the root causes of these problematic scenarios are poor training, and others are adherence to policy. Automation can serve as a solution to this issue; however, sound processes and commitment to policy can prove to be the critical difference.

No matter how low interest rates are or how healthy a balance sheet is, smart CFOs understand that needlessly tying up cash due to highly manual and poorly developed processes is never the right answer. It should also be noted that ineffective cash conversion is a symptom of larger scale problems that may be preventing salespeople from selling, and may be increasing administrative costs. CFOs who drive a cash culture are focused on continuous improvement and seek effective generation of cash and efficient generation. They understand that efficient cash conversion also produces topline revenue growth and bottom-line cost savings.

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