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The Cash Conversion Cycle and Factoring

The Cash Conversion Cycle and Factoring

Many SMEs falter at the point of expansion because they have a limited understanding of its cash conversion cycle and find themselves unable to raise capital or other sources of funding.

For an SME to grow profitably it must come to grips with two key factors on its Balance Sheet. The first is working capital and the second is the Cash Conversion Cycle (CCC). With an understanding of the two we can identify the true funding need and decide if invoice funding could stabilise the cashflow, leading to improved profitability and market share. Working capital is the difference between the current assets of a business and its current liabilities; working capital is the life blood of many SMEs. If positive, it allows a business to purchase or make the products it sells to generate revenue and ultimately profits.

Working capital is also often referred to as the amount of cash on hand to run the business at a point in time. This is wrong.

Working capital is merely a concept that is used to look at the short-term liquidity of a business. It is not a true measure of how much cash is available to pay for required stock or increase in production. For this SMEs need to look at the Cash Conversion Cycle. The CCC clock starts ticking from the time raw material or stock is purchased and continues through manufacturing or shipping and the period that the product sits on the shelf of the customer. All these aspects can affect the length of the CCC. Once sold, the amount of time it takes for the customer to pay for the goods adds to the days that crucial cash is tied up. If credit terms are provided the cycle is further delayed. If you think about it, the CCC could last up to 180 days.

When cash is tied up in the CCC, two scenarios are possible. Either there is insufficient cash to maintain current obligations like wages and other fixed costs, or there is ‘rationing’ of the cash to meet some costs whilst neglecting statutory payments or the funding of any business expansion. A poor cash cycle is tantamount to shouting, “no more orders!” There is no way of funding new sales. However, never fear, there is a solution at hand for SMEs – and it is Factoring.

A FactorONE facility allows an SME to cut short its CCC, thereby releasing cash tied up in invoices. The cycle is substantially shortened and management is free to pursue new orders and win new business. SMEs can therefore extend longer credit periods to customers, which in itself has the ability to increase sales, ultimately securing the ongoing viability and profitability of the business for its owners.

 

 

 

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