Why it pays to shorten your cash cycle
When your business is growing fast, shortening your cash cycle – by getting paid more quickly – can increase your profits.
Faster payments = shorter cash cycles = increased profitability.
We asked Danielle Lyssimachou, Associate Professor in Accounting at Bayes Business School (formerly Cass Business School) to demonstrate the maths behind cash cycles and profitability.
What is a cash cycle?
The cash cycle is the number of days it takes to recover cash spent on inventory. Picture this:
Order sent to supplier.
You spend 80K
Your inventory arrives at the warehouse.
Sale made to customer.
Funds received from your marketplace.
You receive 100K
This is the cash cycle, the amount of time needed to recover your original expenditure. During this time, your investment of 80K has grown to 100K as a result of the successful sale – giving you a 20% profit margin.
A shorter cash cycle is better
A 50 day cash cycle will repeat approximately 7 times a year (365 days / 50 days = 7 cash cycles). If you can shorten your cash cycle to 35 days, then you can run 10 cash cycles a year (365 days / 35 days = 10 cash cycles).
What is the impact on profit?
By adding just three more cash cycles per year, sales and profit rise by 43%. Nothing else has changed: the inventory cost is the same and profit remains at 20%.
Now, if your company is on a growth track and re-invests the profits from each sale, the gains are even larger.
Here are the workings:
How to reduce your cash cycle
Shortening the cash cycle even by a few days can make a significant difference, especially to businesses that have growing sales.
Of course, one of the ways you can do this is by becoming a client of Storfund. We charge a fee that will initially reduce your margin, but in return, the service can more than compensate by elevating your turnover and profitability.
That's why it pays to shorten your cash cycle.