Today’s seven swans a swimming challenge is to calculate one of the most useful KPIs for a business, your cash conversion cycle.
This is the number of days (or weeks) it takes for £1 spent by the business to be returned in cash or the length of time the business owner has to ‘invest’ in the business before a cash return is made.
For a business that sells on credit and holds stock, the cash conversion cycle is the sum of the number of days there are in debtors (before a customer pays) plus the number of days stock is held, LESS the number of days required to pay creditors (before suppliers are paid).
Consider this example: A business buys raw materials for £1 on 30 days credit from a supplier and pays in 35 days. The materials are used to manufacture goods which are placed in stock. 65 days later the goods are sold on credit and the customer takes 45 days to pay.
Number of days before customer pays = 45
Number of days sales held in stock = 65
Number of days before suppliers are paid = 35
Cash conversion cycle = 75 days (65+45-35)
So if annual sales are £500,000, the working capital required is £102,740 as follows: £(500,000 * 75) / 365 = £102,740.
The total of 75 days – the time it takes for the £1 to return to the business – is over ten weeks, which is more than most people realise.
Your challenge today is to calculate, using the chart above, the number of days in your cash conversion cycle.