When the leadership team of a large medical device manufacturer announced that improving Cash Conversion Cycle would be a key part of the strategic plan, it made a lot of folks uneasy. Many of the staff privately admitted they didn’t fully understand the measure. What they did know made cash conversion seem too “high level” to be useful. But an announcement by the VP of Supply Chain made its importance crystal clear: “No more external investment. If you want to grow, you will have to finance it from operations.” Freeing up cash became a top priority. A Cash conversion cycle in excess of 100 days highlighted the low hanging fruit like no other measure could: Too much cash was tied up in inventory.
Long cash conversion cycle is like an old lady driving a 69 Camaro SS; though the car is capable, it won’t win many races. The shorter the cash conversion cycle the closer the driver gets to the car’s full capabilities. If the driver is Amazon, she can do a big, smoky burn out…blowing away the competition. That is what cash conversion can do for your business.
Cash conversion is a highly visible measure of your organization’s supply chain performance. Connecting performance objectives and improvement ideas with a specific cash conversion outcomes can be transformative for your business. Here are some things you should consider if you want to supercharge your organizations cash conversion cycle.
Cash Conversion for Supply Chain Managers
First, let’s demystify the concept. After having spent a fair amount looking through old textbooks (and Google of course), I am taking a crack at "defining" cash conversion for regular, non-financial type managers. This is as simple as I know how to make, so if you need something more official sounding I encourage you to look it up on Wikipedia:
Cash Conversion Cycle is a measure of the time between receiving materials from a supplier and receiving money from buyers of your finished products.
Cash conversion is typically expressed in a number of days and generally ranges from a few hundred to less than zero. Companies like Amazon and Wal-Mart are so good at cash conversion they have negative cash conversion cycles. When cash conversion goes negative it means the business is turning product into cash before the bills come due! This provides maximum financial flexibility and is the place to be if your company is trying to grow through acquisition.
Cash conversion cycle is composed of three primary components:
1) Days Payable Outstanding or DPO
· How long creditors give you to pay them. Since payment terms are usually governed by contract terms, and procurement usually negotiates contracts, Procurement often has the most influence over DPO.
2) Days Inventory Outstanding or DIO
· How long your inventory will last at current sales levels. DIO performance is most often directly controlled by supply chain functions (e.g. Manufacturing, Logistics, Distribution, Operations)
3) Days Sellable Outstanding or DSO
· How long you give customers to pay you. Generally, accounting and/or corporate finance functions have the most influence on DSO performance.
Benchmarking Cash Conversion Cycle
Many times leaders don’t react well to external benchmarks. While it is fair to say that no two business are exactly alike, external benchmarks can help you craft the change message, especially if there is a significant gap between your company’s performance and that of a competitor.
According to the Medical Device and Diagnostic Industry Web sitethe companies listed below are among the top 10 medical device companies in the US. They provide an interesting industry perspective to illustrate cash conversion cycle
Here is an example:
Here is an example:
| Company | CCC | DSO | DIO | DPO | Inventory Value (USD Bn) |
| Johnson& Johnson | 70 | 61 | 41 | -32 | $12.90 |
| GE Healthcare | 44 | 45 | 53 | -55 | $13.70 |
| Seimens AG | 98 | 62 | 73 | -37 | $20.60 |
| Medtronic | 114 | 86 | 41 | -13 | $1.80 |
| Covidien PLC* | 137 | 52 | 128 | -43 | $1.70 |
| Novartis AG | 72 | 65 | 43 | -36 | $6.70 |
| Cardinal Health Inc* | 8 | 22 | 28 | -42 | $7.90 |
(To give you an idea of how easy it is to develop external benchmarks, this table was compiled with a slightly-better-than-dial-up internet connection in less than an hour.)
I like the contrast between Cardinal Health and Covidien. Cardinal is heavily involved in hospital and wholesale distribution, whereas Covidien is primarily a medical device manufacturer. Cardinal’s DIO of 28 days suggests that they are the best product mover on the list. Covidien may have less money tied up in inventory, but a DIO of 128 days suggests that their inventory position (compared to sales) is at the very least conservative. Comparing the two make a pretty clear statement about Covidien’s potential opportunity to lean out inventory.
Obviously this is not the whole picture. I am sure the management at Covidien has perfectly good reasons for their cash conversion cycle. But I think the analysis illustrates the utility of the cash conversion metric, and how it might be useful to supply chain leaders.
Putting it all Together
So, let’s say you're on track to understanding Cash Conversion Cycle and after perusing the analysis you think it could really help your organization. Before you jump in head first, here are some tips that can help you secure buy in and maximize results:
· Educate, educate, educate – If you find your colleagues scratch their heads when you mention cash conversion, arm them with information. A couple of slides with references are easy to develop and can lead to much broader buy in.
· Benchmark – External benchmarks are good, but the best benchmark is your own organizations past performance. If you are part of a larger corporation, look into how other business units are doing. Worst case, you can start measuring it right now.
· Collaborate – Changing cash conversion results is truly a team effort because of its broad scope (receivables, inventory, payables). That makes coordinated cross functional effort vital to creating and sustaining improvement.
· Create meaningful performance objectives – Typically, ERP systems have gigabytes of information on inventory, so it might be easy to break total inventory value down by stock type (i.e. Raw Material, Work-in-Process, Packaging Material, Finished Goods, Etc.) Pushing the data as low as possible enables driving the target as low as possible in the supply chain organization.
· Align performance objectives with Cash Conversion results – particularly in supply chain, but also across the entire organization, it is possible to drive cash conversion targets into the performance objectives of every team member.
Here is an example of how you might segment accountability:
| Function | CCC | DPO | DIO | DSO | Inventory Value |
| Leadership Team |
X
| ||||
| Sales |
X
| ||||
| Marketing |
X
| ||||
| Supply Chain |
X
|
X
|
X
| ||
| Logistics |
X
|
X
| |||
| Operations |
X
|
X
| |||
| Manufacturing |
X
|
X
| |||
| Scheduling |
X
| ||||
| Demand Planning |
X
| ||||
| Procurement |
X
|
X
| |||
| Finance |
X
|
X
|
X
|
Notice the Leadership Team is measured only by cash conversion. It tends to be a good measure of the whole leadership teams effectiveness. As you drive the target down, more detailed targets will help keep the objective smart for each person. For example, a raw material planner could have an aligned inventory value target for the portfolio they manage, but because Cost of Goods Sold is typically only accrued against finished goods, a DIO target would probably seem too abstract.
Leverage Cash Conversion Cycle for Success
Cash conversion can be a fantastic tool for defining meaningful opportunities to improve your company’s financial performance. Even better, it can be sliced and diced at detail levels that enable comprehensive vertical alignment with even rudimentary enterprise data systems. Take a look at cash conversion and think about how your boss, you customers, and your company’s shareholders would view breakthrough, best-in-class outcomes. You might find it is worth a look.
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