“Cash is King” – Do you know your Cash Cycle?

The cash cycle of a business is the amount of time from the point when a business makes an outlay to purchase material to the time cash is collected from the sale from using that material. This concept can be used in all types of businesses.  Shortening the cash cycle can make a big improvement in cash balances and cash management.

The common components of the cash cycle are:

1. Average age of Inventory or Work In Process
2. Average age of Accounts Receivable
3. Average age of Accounts Payable

After one knows the above three components the cash cycle is 1 + 2 – 3.  For example, let’s say the average age of Inventory is 85 days, the average age of Accounts Receivable is 70 days, and the average age of Accounts Payable is 35 days, then the cash cycle would be 85 + 70 – 35 or 120 days.  This means your cash is tied up on average 120 days in the form of Inventory or Accounts Receivable.

The strategy to shorten the cash cycle can be done several ways:

1. Shorten the days of the cash tied up in Inventory or Work In Process
2. Shorten the days of cash tied up in Accounts Receivable
3. Lengthen the days before you pay Accounts Payable
4. An interplay of the above three to meet yours, your customers’, and your suppliers’ needs

This is one cash management tool that can increase cash flow in a time when “Cash is King.”