Cash is king in a new and growing businesses. The faster cash comes in after your work, product or invoice goes out, the better. (Those are your cash conversion cycles.) The less inventory or receivables, the better.
Yet short cash cycles alone don’t grow your business. If you have cash flow problems (empty checking accounts and a constant need for financing, say) they might not be what needs fixing. Cash conversion cycles enable (or are a catalyst) for growth because they free up cash and allow you to fund growth.
But there are a few things a fast cash conversion does NOT do. It does not deliver profitability or good unit economics—that’s built in to your business. If you’re making money and have a good business model, shorter cycles will accelerate the pace at which you can grow the company.
The important point is that it’s possible that your cash-depletion issues lie elsewhere, and focusing on the cash conversion cycle is not what you need to be doing. Here’s what you might not know.
Show Me the Bottlenecks
Let’s talk about bottlenecks. As you grow, not all parts of the business grow evenly. It’s important to look for places where your processes aren’t scaling as well or as fast as other areas. Where, for example, do you still have a manual process? In my last article, “Startup Growing Pains: 3 Tales of Disappearing Cash—And How We Fixed It for Scalable Growth,” you can read how a sales and manufacturing company eliminated serious bottlenecks from its business.
Another example: In my company, AVL, our billing process is very automated. Yet there is a manual process by which we double-check invoices or do some analysis as a quality control to make sure it’s all right. A good question is: should we be doing that? Does it cause delays? If I say “let’s get our invoices out 48 hours after the period ends,” I might discover we can’t do that with the manual process. What bottleneck is in the way?
What worked in your business for when you had 5 clients or sold 1,000 units/month can often break when you grow to 200 clients or 100K units/month. Identifying your bottlenecks will keep profitability, unit economics and your business model running efficiently. These factors will affect your cash.
For the high-growth companies we work with, lots of great processes break with scale. Purchasing, expense reports, compensation plans, budgeting, contracts management, and customer knowledge are great examples of things that don’t scale. So, do you have more people or buy new systems? Who implements those systems? It’s a powerful perspective to take while you strategically look at your company’s growth plan.
Book Recommendation. There’s a classic book that I haven’t heard people talking about recently, which is super helpful for clearing bottlenecks in the growth phase of building your company. It’s called The Goal: A Business Graphic Novel by Eli Goldratt. It’s an awesome business book not only for its lessons around bottlenecks and the theory of constraints, but because the book is written as a novel. It’s a conversational, easy read, not textbook-y.
The characters use the Socratic method of teaching. The main character needs to fix a supply chain and is super frustrated that he can’t get the answer, so he has to figure it out himself. It takes place in more of a manufacturing setting but it’s for any business with growth challenges. It extends into customer service, invoicing and billing. There’s a pick up, there’s a do, and there’s a put down, and then it moves on to the next step.
This book can help entrepreneurs and business owners get their bottleneck cycles fixed so invoicing can happen, collections can happen, and the sales or delivery cycles can shorten. This makes it a great book for improving cash conversion.
Is Cash Conversion Really a Problem You Need to Solve?
How can you figure out if your current cash conversion cycle is a problem? Start by looking at how long the current cycle is. How you calculate that often varies completely by what type of business you have, but the key question is: how fast does the cash come in?
Cash cycles have nothing to do with pricing or cost or expenses or profit. Improving your cash cycle is a catalyst for growth because it’s the limiter in terms of how fast you can grow with current cash. If you’re close to zero cash cycle, then you always have the cash to fuel the next customer or the next product sale.
In some startups, there may not be enough profit (or not enough profit yet) to worry about the cash flow cycle. If you have just a handful of customers or your operations are not good economically, then getting the economics right is more critical than trimming your cash conversion cycle. Cash conversion is not a silver bullet. You’ve got to think about your core issues.
Two Ways to Check Cash Conversion
If you are focusing on the cash conversion cycle, on the operating cycle, then you’re going to need to figure out what that cycle is and look for the low-hanging-fruit-type problems to fix first. There are two methods, or two perspectives, on how to do this. I’m going to go through both, but it’s a little bit complicated, so bear with me.
Method One: Four Cash Cycle Lenses
The first method looks at the four main cash cycles: the sale cycle, the production cycle, delivery cycle, and the billing and collection cycle. (These four are not present in all businesses. E-commerce is different than manufacturing. Something with hardware and implementation is going to be different because of the install, etc.)
1. Sales Cycle. In prior articles I have talked about the order to cash cycle. It’s that point in the sales cycle where there’s an order (or right before an order). How does that order get through the system (which is the sales cycle)? It may call on production to start, or that production could be on a separate timeline. I’ll come back and go into this one in more detail in Part 2 of this article.
2. Production Cycle. Production is all about how long it takes between goods coming in, in raw material form, to inventory on the shelf. If there’s more stuff in the production cycle, you’re going to have more raw material, more WIP, more finished goods, which is going to create more inventory in the balance sheet, which is going to tie up more cash. If you can shorten that, say it arrives in the dock and is on the inventory shelf in 24 hours, then that production cycle is very small and ties up very little inventory and minimal cash.
3. Delivery Time. On the delivery cycle, it says how did we get that served to our customer, are we implementation or install? (For some companies like e-commerce that’s very much a non-issue.) You’re charging a customer, you’ve got a product in transit almost immediately, but even to compete on some of the stuff within the e-commerce world requires a very timely delivery cycle.
One company doing e-commerce for mountain bikes opened a facility on the west coast at first. Then they opened a facility on the east side of the US, specifically to reduce the delivery cycle to customers. They wanted to get the bikes in the hands of the customers in two days, not five or six. Making shipping costs a little less expensive helps here too.
4. Billing and Collection Cycle. Finally, there’s that bill and collect cycle, which is about getting your invoices out and collecting payments on a timely basis. What are your terms? What do you do when invoices aren’t paid? These are issues to consider.
So method one is going through those four cycles in detail. In the next article, I’ll go over the quicker Method 2, and how to fix what you find.