Welcome to Year 4 of The Monthly Metric, where a frequent theme is that the procurement and finance departments should be partners in achieving organizational goals. While the name of this month’s analytic — cash-to-cash cycle time — suggests an emphasis on finance, it can reveal a lot about the health of a supply chain, and success requires striking an ideal balance between customer service, inventory management and supplier relations.
Cash-to-cash cycle time (also known as cash-conversion cycle or order-to-pay cycle) measures the days between (1) the purchase of materials/inventory from a supplier and (2) payment collection for sale of the resulting product(s). A company’s operating capital generates no value if it is tied up in inventory, making cash-to-cash cycle time a critical analytic for finance.
That’s especially true at smaller businesses that must ensure enough money to pay operating expenses during the gap between purchase and payment. Without proper cash-flow management, that gap can widen as a company grows, says Tracey Smith, MBA, MAS, CPSM, president of Numerical Insights LLC, a boutique analytics firm in Charlotte, North Carolina.
“As a business becomes more successful, customer demand increases … but rapid growth is a scenario that catches many small businesses by surprise,” Smith says in a video from Numerical Insights’ Business Survival with Analytics series. “If you’re selling products, you begin to buy more inventory to cover the larger demand. That ties up more cash in inventory, and the amount of cash you need to cover the time between the initial outlay and receiving cash from sales gets larger. A business can run out of cash even though it has a large amount of money owed to it from past sales.”
Alignment between procurement and finance is critical, as those departments should share a reporting structure, cross-functional KPIs and standardized processes. This formula resulted in cash-to-cash cycle time success for a company detailed in a case study below.
Meaning of the Metric
Cash-to-cash cycle time is a metric that is made up of three analytics: days sales outstanding (DSO), days inventory outstanding (DIO) and days payable outstanding (DPO). Adding DSO and DIO, then subtracting DPO calculates cash-to-cash cycle. The three figures can potentially help procurement and finance professionals quickly identify breakdowns in inventory, supply chain or collections processes, and implement improvements to generate more working capital.
Generally, the cash-to-cash cycle time benchmark is 30 to 45 days — and the fewer days, the better it is for small companies that do not have the cash flow to allow for longer payment periods. According to 2014 research by New York-based management consulting firm McKinsey & Company, cash-to-cash cycle time can vary greatly between companies, even those within the same industry sector.
For example, in the energy industry, highest-performing companies had an average cycle time of minus-44 days, while those in the lowest tier were at 53 days. In health care, the time was 49 days for the highest performers, 179 days for laggard companies. Utilities had the smallest gap between the highest (22 days) and lowest (44 days) tiers. The median cash-to-cash cycle time was 44 days in the consumer-discretionary goods companies, 35 days for those in consumer-staples goods, five days in energy, 136 in health care, 71 in industrials, 63 in materials and 34 in utilities.
A cash-to-cash cycle time improvement can free up working capital that, as McKinsey & Company researchers wrote, “be a lifeline” for nascent companies. They continued, “For healthy companies, the windfall can be reinvested in ways that more directly affect value creation, such as growth initiatives or increased balance-sheet flexibility. Moreover, the process of improving working capital can also highlight opportunities in other areas, such as operations, supply chain management, procurement, sales and finance.”
Large companies can make cash-to-cash cycle time a greater challenge for suppliers by negotiating for extended payment terms. According to the 2018 Working Capital Survey by The Hackett Group, a Miami-based business consultancy, the average DPO for U.S. companies is 56.7 days, the highest figure in a decade. Lengthy payment terms provide companies interest-free financing of operations by “borrowing” from suppliers.
A cash-to-cash cycle time champion is Apple, Inc., the Cupertino, California-based technology behemoth that since the 1990s has dramatically moved its figure from a positive number to a negative one. Its cycle time for the third quarter of 2019 was minus-63 days, thanks to a DPO that is more than 100 days. Apple’s market position and vast supplier base enables it to negotiate the most company-friendly payment terms.
Another success story is Lexmark, the Lexington, Kentucky-based manufacturer of laser printers and imaging products. In a competitive marketplace, Lexmark in 2001 sought to improve its standing in part by improving supply chain performance and cash flow. Among the initiatives were (1) rationalizing suppliers, (2) shipping directly to retailers and distributors, (3) improving invoice accuracy, (4) redesigning warehouses to enhance order picking and fulfillment and (5) centralizing accounts-payable processes.
Also, Lexmark sought more favorable payment terms with its suppliers. The result was a 45-percent decline in cash-to-cash cycle days over four years. “Three important factors have helped us to achieve our … goals: creating deeper relationships with fewer suppliers, having a strong organizational structure that helps us get control of costs more quickly and, finally, a relentless focus on execution,” Donna Covington, then Lexmark’s vice president of customer services, wrote in IndustryWeek magazine in 2005.
The C-suite measures a procurement department’s success primarily by its return on investment, and a major element of that is cash flow. Synergy between the procurement and finance departments is required to reduce the time between purchase and payment, and an improvement in cash-to-cash cycle time can unlock game-changing capital for a company.
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