Good or bad understanding of working capital requirement can make or break a business. A good understanding of working capital requirement and effective implementation of the same, in the business forms a key to the success of any business operation.
A key component of working capital management is cash to cash cycle. In layman’s terminology the time duration between you spend the money and getting a return. If the time duration is long your working capital requirement goes up and vice versa.
Let’s take an example of a small business who buys products from manufacturer and sells it to his/her customer at a profit. Say he/she buys a product from manufacturer on day 1 and he/she pays the manufacturer in day 5. He/She had to keep that product in stock till day 15 before he was able sell it to his/her customer. The customer pays the amount to him/her on day 20. Thus, his/her cash to cash cycle is:
Number of days the product remained with him/her (15)+ Number of days the customer took to pay of his/her dues (20-15=5) – Number of days he/she took to pay of his dues(5-1=4)=16 days.
Thus, it took 16 days for him/her to get back his/her money from the system. All his/her working capital planning should be based on this calculation. As mentioned earlier everyone ideally like to keep this number as low as possible.
As per the equation above. There are 3 ways by he/she can keep this number low:
- Clear the manufacturer’s due as late as possible
- Keep the product with him/her for as little time as possible
- Collect due from customer as soon as possible
All the 3 choices have its limitation. Paying manufacturer late might irk him/her as his/her cash to cash cycle is adversely affected and he/she might decide not to supply products in future. Keeping the product for as little time as possible might lead to customers coming to the establishment and not finding the product. Collect due from customer as soon as possible might compel customer to turn away to the competitors who have more relax collection policy.
Ideally, all businesses tries to find a balance of all the 3 components.
To find the right balance it is important to keep track of this dynamic data. This becomes a challenge in real life situation as businesses usually deal in thousands of products, hundreds of customers and many suppliers. Each supplier has different credit policy and that policy also remain dynamic. Each product stays as stock for different time period. Each customer has a different payment policy too.
Perfview Management Consulting helps business to breaks this complex number game with an interactive user friendly data visualization. Where you can see average credit period allowed by supplier, average number of days a product remains on your inventory and average number of days customer clear his/her dues.
This helps business to make inform decision whether to continue with a particular supplier or customer and what should be the re ordering time of any particular product. This will enable businesses to bring down its cash to cash cycle effectively.
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