One of the keys to not only surviving but thriving during this upcoming recession is to gain control of your cash conversion cycle. Here’s how you can do that.
Memories of the Great Recession of 2008, which lasted 18 months, are looming again in the minds of many economists and business leaders.
The National Association of Business Executives reports that 72% of economists expect the next recession will start by the middle of 2023. But 19% say the country is already in the midst of a recession, according to the National Bureau of Economic Research.
Then there is the very real possibility that companies could put their digital transformation efforts on hold or shut them down entirely due to recession fears. This is despite business leaders being well aware of automation’s long-term benefits and critical advantages.
One of the keys to not only surviving but thriving during this upcoming recession is to gain control of your cash conversion cycle. Simply put, you calculate cash conversion by taking the number of days inventory is outstanding (DIO), adding the days sales are outstanding (DSO), then subtracting the days payables are outstanding (DPO).
The shorter your cash conversion cycle, the healthier your cashflow is. The question is — how do you go about shortening the cycle in both solid and shaky economic times?
Below are five tips to recession-proof your cash conversion cycle:
1. Take the pulse of your business
Before shoring up your processes or making improvements, you need to know where you’re starting from. Review customer categories, at-risk cash, aging balance, collections and more. Examine how to prioritize your work and adjust personnel and resources as needed. Monitor the evolution of daily performance and cash forecasting — the amount of money you expect to come in. Once you’ve gathered this information, make data-backed decisions to adjust your processes.
2. Reduce your DIO
A protracted global pandemic wreaked havoc on the supply chain, making it more challenging to manage your DIO. Yet this is critical to your cash cycle. This number needs to be as low as possible to maximize your cashflow.
Despite the recent global supply chain disruption, there are still steps you can take to reduce DIO. Very often, problems with longer DIO and supply chain issues stem from manual processes. It could be as simple as an employee making a mistake or poor communication between your employee and supplier.
Regardless of the cause, automating your order management process is the key to resolving these issues. This will lead to greater accuracy in your inventory, so you don’t have too much (or too little) in stock. Once extracted and integrated into your planning software, you’ll have a wealth of data on which to apply business analytics to provide actionable insights.
3. Reduce your DSO
Like DIO, you want your days sales outstanding (DSO) to be as low as possible. Using a manual invoicing system can increase DSO. In addition to the personnel time required to physically prepare, print and mail out invoices, you’re at the mercy of the postal system to deliver invoices. The recent changes to the USPS means it can take four or more days to deliver invoices, depending on the time of year and staffing levels.
Switching to an automated system with electronic delivery will reduce your DSO. Not only will invoices get to your client much quicker, but you’ll also be able to track the receipt and status of each invoice, not to mention reducing the costs of admin time, paper, printing and postage. Finally, an automated system could increase your client satisfaction, as they’ll have more time to process invoices and resolve any issues that may arise.
4. Reduce your DPO
How long does it take companies to pay invoices? If your terms are net 30 or 60, do you have clients that wait until the last moment, or even worse, always pay late? Reducing your days payment outstanding (DPO) will improve your cashflow.
If you acted on the previous tip of using an automated system to send invoices, you’ve made the first step. Getting your invoices in the hands of your customers sooner could lead to them paying earlier. Plus, you could offer discounts to clients to get them to pay earlier.
Conversely, for customers having problems paying their bills, you could renegotiate their terms, making it easier for them to submit a payment on time and keep their accounts out of collections. With an automated system, this is easy to do on a case-by-case basis. Plus, you both benefit — the customer breathes a sigh of relief while you still have cash coming in.
Additionally, an automated system can allow you to customize your process to collect cash quickly. You can start by going after accounts that are past due and continue by targeting accounts that have the highest amount outstanding.
5. Repeat the process
So, you’ve adjusted inefficient processes and added automation where it makes sense to manage supply chain and inventory, issue invoices and collect on those invoices. But recession-proofing your cash conversion cycle isn’t done yet. Neither process improvement nor digital transformation is a once-and-done initiative. To fully optimize the system and have it perform at maximum efficiency, you must continually evaluate each step along the way. You may want to add some steps and adjust others, while others can simply be eliminated. Since the goal is to reduce your DIO, DSO and DPO, you’ll want to fine-tune the process continuously.
By taking these five steps, you’ll hopefully reduce each of these metrics and see real improvement to your cash conversion cycle. When this happens, whether the economy is growing or shrinking, your company will be in a healthier position to weather the storm and even come out ahead.