Cash Cycle … Who’s Managing It?
Cash is, without a doubt, the life-blood of a business! Unfortunately, rapidly
changing conditions impact cash and the amount a company has invested in its own cash
cycle. Yet, so many business owners neither know how much they have invested in their
cash cycle or how to manage it well.
A company’s cash cycle is a measurement in days of the amount of cash a company
has committed in its inventory, receivables and payables. The measurement in days reflects
the effectiveness of management to minimize the time it takes to convert a dollar invested in
inventory until it becomes a dollar collected from accounts receivable, while taking
advantage of the free financing provided by suppliers in accounts payable.
The primary goal is to reduce the number of the days in the cash cycle to the least
possible without negatively affecting the business through inventory shortages or too
stringent credit policies. The ultimate goal is a negative cash cycle thereby using suppliers’
money to finance daily operations
In the petroleum marketer industry the cash cycle is acutely critical to monitor due to
the volatile swings marketers experience during rapidly changing fuel prices, changes in their
customers’ payment patterns, and the manner in which they pay their suppliers. Any or all of
these can change quickly creating enormous burdens on companies to fund their cash cycle.
It is critical that marketers know and understand the dynamic forces of the cash cycle and
how to calculate and manage the cash they have invested in their company’s operations.
To accurately calculate the cash cycle one must determine the number of days a
company has cash invested in their cash cycle components:
1. Average Age of Inventory
2. Average Collection Period of Accounts Receivable
3. Average Payment Period of Accounts Payable
The calculation of each of the cash cycle components for any twelve month period is
as follows:
1. Inventory: [Inventory –divided by- (Cost of Goods Sold / 365)]
2. Accts. Rec.: [Accounts Receivable –divided by- (Sales / 365)
3. Accts Pay.: [Accounts Payable –divided by- (Cost of Goods Sold / 365) ]
Note: Italicized section of the formula calculates the individual day volume for each component. By
dividing the component by the individual day volume the number of days in each component is determined.
The following format can used to assist management in the analysis of their company’s
cash cycle for any twelve month period:
Average Days
In
Row
Inventory
1. Add Ending Inventory for
the last 12 months and
divide by 12 which equals:
Average Ending Inventory.
2. Add Cost of Goods Sold for
the last 12 months and
divide by 365, which equals:
Day of Cost of Goods.
3. Divide the answer of Row 1
by the answer of row 2,
which equals:
Average Days in Inventory
Average Collection
Days in
Accounts Receivable
Add Account Receivable for the
last 12 months and divide by 12
which equals:
Average Accounts Receivable
Add Total Sales for the last
12 months and divide by
365, which equals:
Day of Total Sales.
Divide the answer of Row 1
by the answer of row 2,
which equals:
Average Collection Days
Average Payment
Days in
Accounts Payable
Add Accounts Payable for
the last 12 months and
divide by 12 which equals:
Average Accounts Payable
Add Cost of Goods Sold for
the last 12 months and
divide by 365, which equals:
Day of Cost of Goods.
Divide the answer of Row 1
by the answer of row 2,
which equals:
Average Payment Days
In the chart that follows one can readily see the dynamic difference between the
company’s investment in dollars in inventory and receivables versus the benefit it receives in the
receipt of spontaneous, non-interest bearing debt from accounts payable suppliers. The number
of days of free-money from accounts payable suppliers is a direct reduction against the number
of days a company has its own cash committed in inventory and receivables. The sum of the
company’s collection days and inventory holding days offset by the free-cash days provided by
accounts payable suppliers determines the Net Cash Days in a company’s cash cycle.
GRAPHIC CHART SHOWING RELATIONSHIP ENTERED HERE!
Petroleum marketers have different cash cycles for different types of business models.
One size does not fit all! Marketers with large sales volumes in wholesale commercial lubes
and light fuels to commercial and industrial accounts and cardlocks will usually have much
larger inventory and receivable days than a jobber whose business model consists of running
company operated convenience stores or a company that primarily has supply contracts with
dealers.
The following four jobber business models were broadly defined to allow the reader the
opportunity to better benchmark their specific type of distributorship:
1. Lubes: Heavy emphasis on commercial lubes and some wholesale fuel.
2. Dealers: Primary focus servicing dealers – predominately wholesale fuel.
3. Conv. Stores: Company-operated and/or leased convenience stores with light fuels.
4. Hybrid: Jobbership containing some of all of the above.
Average Age of Inventory (Days)
+ Average Collection Period (Days)
- Average Payment Period (Days)
Net Cash Cycle Days
Basic Four Petroleum Marketer Business Models
1
2
3
4
15.2
2.8
9.7
12.3
26.5
3.1
5.4
18.2
(28.5)
(14.3)
(13.1)
(23.5)
13.2
(8.4)
2.0
7.0
The Net Cash Days presented in the chart above for each business model was obtained from
marketers all around the country for the trailing twelve month period ended April 30, 2003. Their
individual business model profiles were analyzed and sorted respectively. The respective cash
cycles presented are not intended to be a definitive study of the types of business models available to
marketers, or the relative advantages or disadvantages of each business model. The illustration is
intended to provide a range of timely operating benchmarks from which to begin your company’s
analysis. For is there any more critical asset to manage than … cash?