Days Sales Outstanding

+ Days Inventory Outstanding

– Days Payable Outstanding

= CASH CONVERSION CYCLE

Treasury Management Advisor2013 > Third Quarter Understanding the Working Capital

Optimization Cycle: Improve Your Cash Conversion ProcessHaving less cash tied up in receivables, payables and inventory means having more cash available for paying down debt or investing in your business. The working capital optimization, or cash conversion cycle, allows you to look at these three areas to determine where your cash is tied up, says Jason Sweatt, Vice President and Liquidity and Deposits Group Manager.

Jason recently shared his thoughts about working capital and what it could mean for your business.

What is the working capital optimization cycle?The working capital optimization cycle is a way of analyzing a company’s receivables, payables and inventory to determine how the company handles the cash in order to meet the short term liquidity needs of the operation.

The cycle provides insight into how much working capital it takes to run your business.

Again, there are three aspects and perspectives to consider: receivables, payables and inventory. A receivables perspective shows how many days it takes to get paid. A payables perspective shows how long it takes to pay your vendors. An inventory perspective shows you how long it takes to turn over your inventory.

How do you calculate the working capital optimization cycle?To calculate receivables (days sales outstanding): accounts receivable / sales x 365. This will determine how long it takes to get paid for the products or services you provide.

To calculate payables (days payable outstanding): accounts payable / cost of goods sold x 365. This equation will tell you how long it takes to pay your vendors.

To calculate your inventory (days inventory outstanding): inventory / cost of goods sold x 365. This will reveal how long cash is tied up in inventory.

To calculate the working capital optimization cycle (cash conversion cycle): days sales outstanding + days inventory outstanding - days payable outstanding. This formula will determine how long it takes to turn over your cash. The final number will vary depending on your individual business and industry. However, your business should look at its working capital optimization cycle year over year to see how you are performing and compare yourself to your peers. The information for publicly traded companies is available online to use as a benchmark, while peer information may be provided by your banker.

How can a business manage these three aspects to increase cash flow?You want to get receivables in as fast as possible, and you do that by having the right mix of treasury management services, such as by having your clients pay you by Automated Clearing House (ACH) or wire. You can also offer a discount for clients who pay quickly to encourage sustained prompt payment.

On the payables side, you want to avoid early payment to vendors, unless there’s a discount for early payment. One method of managing your payments is to use

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Jason Sweatt Vice President and Liquidity & Deposits Group Manager

Treasury Management Advisor2013 > Third Quarter

a purchasing card, which most vendors accept. You want to hang on to your cash as long as you can so that you can use it to invest or to pay down your debt.

Effective inventory management varies depending on the business, but each business needs to optimize inventory levels with an understanding of the funds that are tied up in excess supplies. Lean manufacturing and just-in-time supplies are two popular inventory management techniques.

How can a business shorten its working capital optimization cycle?Again, businesses can benefit greatly from employing the right mix of treasury management products. Taking checks to the bank yourself takes time, but a remote deposit capture product allows you to deposit checks directly from your desk and often provides a later deposit cutoff deadline for same-day credit than branch deposits.

You can also use a lockbox, which speeds up the deposit process and provides access to funds a few days sooner than if you had taken the money to the bank.

Cash-intensive businesses may want to use an electronic vault service. Cashiers deposit money into an “on premises” vault that transmits the amount to the bank, providing daily access to funds.

Why is understanding the working capital optimization cycle so important?It allows you to make more money, which is done through either paying down debt such as a line of credit or being able to invest funds quicker so you have a rate of return on your cash instead of it stagnating in the cycle. It also provides the additional insight necessary to make better informed financial decisions for your business.

For example, in calculating the working capital optimization cycle of one client, we noticed that from 2011 to 2012 the company’s receivables slowed by 10 days. The client said it was the nature of his business with today’s economy, and his receivables contracts had increased to 60 days net pay.

Regions suggested the business convert its paper-based payments to ACH, which would generate savings of more than $500 a month. The ACH process also shortened the working capital optimization cycle by delivering funds quicker and providing access sooner.

The working capital optimization cycleis a strategic focus at Regions Bank on which our bankers are trained. For more information about the process or how Regions can help your business, email Jason.Sweatt@regions.com or call Jason at (205) 264-7419.