The cash conversion cycle (CCC) is one of several measures of management effectiveness. It measures how fast a company can convert cash on hand into even more cash on hand. The CCC does this by following the cash as it is first converted into inventory and accounts payable (AP), through sales and accounts receivable (AR), and then back into cash. Generally, the lower this number is, the better for the company. Although it should be combined with other metrics (such as return on equity and return on assets) it can be especially useful for comparing close competitors because the company with the lowest CCC is often the one with better management.

What is CCC?
The CCC is a combination of several activity ratios involving accounts receivable, accounts payable and inventory turnover. AR and inventory are short-term assets, while AP is a liability; all of these ratios are found on the balance sheet. In essence, the ratios indicate how efficiently management is using short-term assets and liabilities to generate cash.

How do these ratios relate to business? If the company sells what people want to buy, cash cycles through the business quickly. If management cannot figure out what sells, the CCC slows down. For instance, if too much inventory builds up, cash is tied up in goods that cannot be sold - this is not good news for the company. In order to move out this inventory quickly, management might have to slash prices, possibly selling its product at a loss. If AR is handled poorly, it means that the company is having difficulty collecting payment from customers. This is because AR is essentially a loan to the customer, so the company loses out whenever customers delay payment. The longer a company has to wait to be paid, the longer that money is unavailable for investment elsewhere. On the other hand, the company benefits by slowing down payment of AP to its suppliers, because that allows the company to make use of the money for longer.

What goes into calculating CCC, let's take a look at the formula:
    CCC = DIO + DSO - DPO

Let's look at each component and how it relates to the business activities discussed above.
Days Inventory Outstanding (DIO): This addresses the question of how many days it takes to sell the entire inventory. The smaller this number is, the better.
    DIO = Average inventory/COGS per day
        Average Inventory = (beginning inventory + ending inventory)/2

Days Sales Outstanding (DSO): This looks at the number of days needed to collect on sales and involves AR. While cash-only sales have a DSO of zero, people do use credit extended by the company, so this number is going to be positive. Again, smaller is better.
    DSO = Average AR / Revenue per day
        Average AR= (beginning AR + ending AR)/2

Days Payable Outstanding (DPO): This involves the company's payment of its own bills or AP. If this can be maximized, the company holds onto cash longer, maximizing its investment potential; therefore, a longer DPO is better.
    DPO = Average AP / COGS per day
        Average AP = (beginning AP + ending AP)/2

What Now?
As a stand alone number, CCC doesn't mean very much. Instead, it should be used to track a company over time and to compare the company to its competitors.
When tracking over time, determine CCC over several years and look for an improvement or worsening of the value. CCC changes should be examined over several years to get the best sense of how things are changing.

The cash conversion cycle is one of several tools that can help you evaluate management, especially if it is calculated for several consecutive time periods and for several competitors. Decreasing or steady CCCs are good, while rising ones should motivate you to dig a bit deeper.

Non-recourse factoring occurs when the accounts receivable are sold at an agreed upon price, and the factor assumes all of the risk for collecting the accounts. Non-recourse factoring is a more expensive form of factoring but the seller has no credit risk. Thus, if the invoice is not paid the seller has no obligation to pay the factoring firm back.

With recourse factoring, the factoring firm does not guarantee the credit-worthiness of the client’s accounts, and the client sustains losses from any uncollected receivables.  Recourse factoring is less expensive due the fact the credit risk stays with the seller but if the seller has strong, credit worthy clients, then this is the best factoring option. 

• Small businesses and rapidly growing firms are often good candidates for factoring.
• Factoring provides a source of cash for businesses that might not qualify for traditional bank loans or lines of credit.
• Factoring offers a company access to cash while it waits for its customers to pay for goods or services provided.

Factoring can be an attractive alternative for companies that need to improve their cash flow but don’t have access to bank financing or don’t want to increase their debt load, such as small, newer companies and rapidly growing firms.  The factoring firm typically charges a commission fee on the receivables. The business then can receive an advance on the receivables and is charged for interest on the advance.

The key advantage is that the business doesn’t have to wait 30 days or longer for its customers to pay for the goods or services. The business now has access to cash to meet current needs, such as payroll or other operating expenses.

Another advantage of using a factoring firm is the expertise they have in evaluating the credit quality of their customers. Companies also can save money by downsizing or eliminating their credit and collections staff.

How you present an invoice is very important. Most AP departments prefer to pay from an original invoice because payments made against copies of invoices represent a significant portion of duplicate and fraudulent payments. Some AP departments often have policies requiring payment from an original invoice and others have strict processes to follow when paying from a copy that requires additional research and delays payment.

Smudged numbers can cause payment delays and errors. An invoice's information is only as good as the equipment that produces it.

If your company sends paper invoices, present your invoices on white paper using black ink. Do not use colored paper, even if you are tempted to make your invoice distinctive. It does not help get your invoice processed more quickly, and in fact, slows payment if invoices are scanned electronically and the equipment cannot read invoices printed on colored paper. In addition, white paper is less usually expensive and will save you money.

Invoices should be clearly marked "INVOICE."

If incorrect or untimely invoices are sent, it has a negative impact on a company's cash flow. Incorrect invoicing is the biggest reason customers do not pay on a timely basis, so distributing correct invoices helps improve your company's cash flow.

To obtain cash, companies must send invoices quickly and accurately. Invoice as soon as the work is complete. Ensure all documentation is collected and organized before an invoice is issued. The invoice process should begin as soon as the work order is fulfilled.

A contract or sales agreement may specify payment terms, such as when the invoice will be sent and when it is expected to be paid. Otherwise, a sale is considered to occur when a product's title of ownership is transferred to the customer or delivery of services to the customer is completed. If a company's financial records are maintained in accordance with Generally Accepted Accounting Principles (GAAP), sales are recorded once a service or product is delivered. So, invoicing should occur at - or as soon as possible after - this point.

A transaction is considered earned and revenue may be recognized when the following four conditions are met:

• There is persuasive evidence that an arrangement exists, such as a contract, sales agreement or purchase order.
• The fee charged is fixed or determinable.
• The delivery or performance has occurred.
• Collectability is reasonably assured.

To be sure your company has a sound credit policy, there are a number of steps you can take. First, you should have written credit policies and a well-defined document for credit agreements and credit applications. Contracts, invoices and follow-up letters should be clear and policy manuals should outline the guidelines for assessing credit risks. Methods for collections should be clarified for the customer and timetables for collections should be properly spelled out. As a backup, you should have a creditors’ rights attorney available and your company should also have an established relationship with an ethical, bonded collection agency. Finally, as a last resort, there should be well defined criteria for making decisions about when to further pursue or write off a delinquent account. Taking steps to be thorough will optimize the credit relationship with your customers and improve your chances of being paid in a timely fashion.

Credit crunch, part two? The latest data from the Federal Reserve show that banks are tightening their standards for loans to companies with less than $50 million in annual revenue, even as loan demand is ticking up. The good news: Plenty of small banks, asset-based lenders and factors are still willing to deal. But all that could change fast if the European debt crisis worsens (and spreads) and the U.S. economy continues to limp along. Our advice to capital-hungry entrepreneurs: Get it while it’s still lukewarm.

The economy is accelerating at a sluggish pace, and world headlines cause business leaders to swing between optimism and pessimism daily. Businesses must look more closely and much more frequently at their customers’ behavior to stay ahead of emerging credit problems. Success comes from discipline and commitment to the following steps: 

1. Use all customer information when making decisions. Combining both internal and external data can paint a clearer picture of your customers.
2. Identify the customer relationships that have value and should be retained. Apply resources accordingly.
3. Implement daily triggers so you have the latest customer information around bankruptcy, repossession or loan delinquency, as well as positive information such as payments made to other financial institutions.
4. Use next-generation collections software to keep collectors up to date on account-level strategies.

Factoring loans can help companies of all sizes, from start-ups to mature companies:

• Improve cash flow
• Eliminate bad debts
• Reduce operating expenses
• Expand working capital financing
• Improve management information through on-line reports, such as:
  Customer payments
  Accounts receivable agings
  Loan status
  Credit approvals
  Customer deductions and dispute summaries