As they say, cash is king. And nothing can be more catastrophic to an entrepreneur than running out of cash. But, what metrics are best for tracking how effectively you are generating cash? In the first of a three part series we’ll take a deep dive into the mother of all cash metrics – the Cash Conversion Cycle.
Cash Conversion Cycle (CCC) is actually made up of three different metrics. The first measures how long it takes your business to sell your product or service, the second measures how long it takes you to collect cash from your customers, and the third measures how long it takes you to pay your vendors. Cash out + cash in – cash out.
Let’s take a closer look at the first metric, the Days Inventory Outstanding or DIO. This is a measure of how long it takes your business to sell your inventory or service.
Having a low DIO compared to your industry could mean that you are effective at managing and turning over your inventory. However, a low rate could also mean that you’ve written down inventory values or that you aren’t carrying enough inventory to keep up with demand.
A high DIO relative to a benchmark measure can signal that your products are either not easily sold or are obsolete. Therefore, it is crucial to find a benchmark measure or your own historical measure to provide a comparison.
Businesses or industries that traditionally have a high turnover of inventory (like a grocery store) have low DIOs. Conversely businesses with low turnover rates (like a furniture retailer) have high DIOs.
Let’s say AFAB Inc. has $9.55M in inventory and their COGS was $29M, making their DIO 120. This means that on average it takes AFAB 120 days to turnover its inventory. Let’s say they reduced their inventory by 10% to $8.6M. That would reduce their DIO by 12 days. This metric gives you a way to measure the impact your current inventory levels have on your ability to convert it into cash – a powerful tool for any business.
Next, we will dive into the next part of CCC – Days Sales Outstanding.
If you would like to learn more about how a business dashboard can help your DIO, schedule a demo at: www.HuddleBoards.com.
Read Part II – Best Metric to Track Cash