Signs of the Times - July 2017 - 20

AT LARGE

pay the bills and still have end-ofmonth money in the bank.
Berman and Knight break the cashconversion cycle into four stages: raw
materials purchased, payment for
those materials (which could occur
days later), sale of finished goods and
cash collected on the sale. They're
saying that once you buy materials
for an in-process job, you have, in effect,
extended a line of credit to your client,
a line that remains until the transaction is paid. (Paid as in cash-received
paid, not accounts-receivable paid.)
The HBR writers outline three critical
categories for determining a cash conversion cycle: days sales outstanding
(DSO), days in inventory (DII) and
days payable outstanding (DPO).

The DSO average tells of your
average collection period and reveals
how well your accounts receivable are
handled. You calculate the ratio like
this: Accounts receivable / average
sales per day = DSO ratio. You can
change the time element: DSO ratio
= accounts receivable / 365 days
( for annual sales), to calculate the
relationship between outstanding
receivables and credit account sales
achieved over a given period. In
general, this figure reveals how long,
on average, it takes your accounts to
pay up. A higher number says your
collections are lagging and your cash
flow could be improved.
The DII figure speaks of average
days taken to convert inventory

(materials) into a paid sale; it reveals
the number of days your money is
tied up in inventory.
The DPO gives a company's average
payable period, meaning, how long it
takes to pay its trade creditors. DPO
is critical because it addresses the
equilibrium between a company's
money in the bank and the time it
takes to pay its bills. Although money
in the bank is good, your creditors
won't enjoy slow payments and payment tardiness could backfire should
you need special favors or a new credit
approval. However (and conversely),
extending the DPO is one way to
handle a temporary cash shortfall.
HBR's formula for determining
how fast your company regains its
cash outlay is this:
Cash conversion cycle =
DSO + DII - DPO
Their example looks like this:
54 days + 74 days - 55 days = 73
days as the cash conversion cycle.

Because sign work varies, shop managers, to reduce the cash conversion period
and visually see the risks, should track both the expenditures for each sign type
and the total project expenditures, even if assigned to different departments.
20

SIGNS OF THE TIMES

JULY 2017

Berman and Knight say knowing this
time figure is important because with
it, you can determine how many days
the process takes and then understand
how many days ( for that project) your
company's cash is tied up. In their
example, 73 days ends the accounts
receivable period, and, thus the cost
conversion cycle. Berman and Knight
also say you can affect the cash conversion cycle by decreasing the DSO,
decreasing inventory and increasing
the DPO. Of course, you can also
lessen any order risk by requiring a
deposit.
Definitively, you can figure all this
on the back on an envelope, but a
better system is to include such
figures as part of each job costing
file, or as an overall analysis in your
monthly accounting recap.
Table of Contents for the Digital Edition of Signs of the Times - July 2017
