Let’s look at some examples
Example 1: how to manage cash flow in retail
Fred is a wholesaler who sells bikes to retail bike stores. He buys the bikes from the manufacturers who have 60-day payment terms (DPO). His retailers pay him within 90 days (DSO). Generally, he has the bikes for about 30 days (DIO) before getting them to his retailers.
30 (DIO) + 90 (DSO) – 60 (DPO) = 60
Based on this, Fred’s CCC is 60 days – which means he needs to have enough working capital to cover an average 60 days of operational costs before he will be paid. To increase efficiency and shorten the CCC, he could look at renegotiating payment terms with his suppliers and customers, or moving the stock to the retailers earlier.
Example 2: how to manage cash flow in construction or a services business
Hardhats is a labour hire firm that places construction workers. Workers are paid every 14 days (DPO). Hardhats receives payment from its clients 30 days after invoicing them (DSO). It takes on average 10 days to find work for each Hardhats contractor (DIO).
10 (DIO) + 30 (DSO) – 14 (DPO) = 26
The CCC of Hardhats is 26 days. That means they have to cover an average of 26 days of salaries and operational costs before their investment is recouped.
So what’s a good benchmark?
It’s hard to give an absolute CCC benchmark to aim for, as conditions vary widely between industries and business models. As such, you may find it helpful to compare your CCC with competitors in your industry.
Some businesses, like online retailers, may have a negative CCC, as they don’t hold on to inventory for long and receive payment for sales before paying suppliers. Telecommunications companies may also have a negative CCC, as they often take payment before providing the service.
On the other hand, car manufacturers have a high CCC. That’s because they need to order well in advance and have to allow time for shipping and moving cars via the showroom floor.
How the CCC helps with cash flow management
Understanding your CCC can help you identify any areas in your business that are choke points or opportunities for greater liquidity. This can help you avoid any cash flow gaps and let you know when extra cash is available to invest in your business.