The Power of Triple C’s - Cash Conversion Cycle

The previous article closed with the question: Do you have money NOT to sell?


Well, yes… often companies don’t have enough funds to finance sales or open new markets. Although situations might differ from company to company, there are some fundamental characteristics of the industry.

#cashconversioncycle #finance #marketing #productdevelopment #marketentry #investments


Petrus Van Schendel, The Night Market (1844)

The food industry. Crowded. Highly competitive. Cheap to enter. Expensive to stay.


From the manufacturer side, everyone is quite successful to take care of their entry tickets and to launch the production of the product. Once the plant is on, and running, there’s a question that comes as late as the girl to the first date:


"Who will buy it?"


While the food market is demanding towards high investments to get the product on the shelf and then to pull it off, for the manufacturers it’s hard to grasp the fact that millions of euros that they have invested in plants and machinery is not the reason people are going to buy the product!

To open a new market requires more time, more investments and new investors.


But the law of attraction in the finance world is – money attracts money. And the chances are – if the financial planning is very weak in the company, investors are going to pass by. And for a reason - would you invest in company or people, who are trying to keep afloat 95% of their time in business?


However, there are certain things that manufacturers shall consider financially before getting into the debt for the sake of “millions-worth-no-way-out” purchases.


The constant work with investors and attracting funds for the company’s growth is important for stability, still it’s more important to know for what things and which phase in the product launch do you need an investor? Depending on the investment’s purpose, you can calculate what are the chances to have the ROI positive! It might be easy to find investors for low-liquidity assets, as your plant, estate etc., however the interest % is very high, moreover it’s not the asset that will directly generate sales and profit to pay the interest % from.


From my professional experience, manufacturer takes more pride of their investment into low-liquidity assets, instead of high liquidity. Nevertheless, the high liquidity is the one, that can generate sales and cash quickly. Therefore, manufacturers shall see where the true value of the product lies in! And the answer is simple – in the market. Because customer’s choice to take the product home is that moment, when the exchange of the liquidity happens!


This fact takes us further to the metric that has reached the top priority for investors to understand the company’s financial health and growth capacity – the cash flow. That translates into the company’s ability to generate and convert the cash into a profit, and later a profit into a more cash. The reason this metric is the center of attention of many investors, is because it is not subject to estimations or assumptions, rather it’s the reflection of exact situation, unlike other metrics. (Berman et al, 2013)


What’s important – the cash will save you even when the investment or debt capital is hard to come by. Which will equally make you more attractive to investor as a business professional – because with or without the extra support from the investor, you take care of the company’s health to exist!

For the manufacturers, how does that relate to investments into machinery and plants? Let’s take the simple formula of the Free Cash Flow:


Free Cash Flow = Operating Cash flow – Net Capital Expenditures


The equation financially evidences the idea of, sometimes, very unnecessary spending of the capital on the company’s very immovable and low-liquidity assets - as plants and buildings. In this equation such illiquid expenditures eat up the free cash flow, which is the first, direct source to finance the company’s sales on the market!


Furthermore, the cash flows thru its Cash Conversion Cycle (CCC), where the CCC is directly related to the Product Conversion Cycle. Your product is the only asset, that will allow you to cash in due to its high liquidity.


The cash is tied up to different stages of the product: First, the cash goes out to purchase the raw materials. Second, the cash is tied to the product in the production process. Finally, when the product is ready and sells onto the market, the cash comes back in.


When the first CCC is over, the final outcome in the form of profit transforms into the cash again to invest into the raw material to start the second CCC, the third… and so on until we wake up one day, and say: “Oh, now it’s time to invest into the plant and machinery, because the sales have reached the level, where I need to expand my production.. and I can actually sustain it!”


And the shorter is the CCC the more efficient and faster you can meet the growth! Here are just a few questions to ask about your CCC efficiency:


How to cut the Time-to-Market?

Is our product slow or fast-moving?

How can we improve the product portfolio?

How many stores do we need to sell to, to fully complete one CCC?


It is very important to work with investors, partner with financial institutions and source diverse ways of investments to sustain the business growth thru the whole CCC. And, healthy financial performance and planning for the company will attract investors and ease the drama, which often arises due to lack of financial planning.


These considerations will help to prevent the market phenomena as: selling off the plant, discontinuing the product during the launch phase, and finally, not having the money to open new markets!


Bibliography:

Berman et al., 2013, Financial Intelligence: A managers guide to knowing what the numbers really mean. Harvard Business Review Press, USA: Boston.

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