For non-financial professionals (and there are a lot of us!), meetings with the CFO and other finance-savvy colleagues sometimes feel like a film in Inuktitut*, without us knowing a word of the language.
Corporate finance is rich in terminology that can seem threatening to the untrained eye. Our aim here is to explore with you the intricacies of this unfamiliar territory, so that you can impress your peers at your next meeting... and contribute more actively.
Today's choice is cash flow rotation, also known as the cash conversion cycle.
In simple terms, this cycle measures the speed with which an organization transforms its investments into cash.
Before our neurons get overheated, let's take a concrete example! Imagine you want to sell waffles to finance your children's school trip to the Kerguelen Islands.
You spend money on ingredients, a table and a tray to display your delicious creations, for a total of €50. And you earn money by selling the waffles, for a total of €100. Cash flow is the time it takes you to buy the equipment and ingredients, cook the waffles, sell them and collect payment.
In other words, that's how long it takes to recover the €50 you've invested (plus the €50 profit). The sooner you get back the 50 € you invested, the sooner you can buy ingredients again, the sooner you can prepare another tray, and the sooner you can sell them and make a profit.
Can you see the limit?
If you don't have outside investors, you depend on getting that €50 back to continue investing in your waffle business, pay off your debts - last year's lemonade stand debts - and more. If you don't recoup your initial investment quickly enough, you can't expand or invest further.
It can also get complicated: if the table you've rented has to be paid for before you collect payment, but you don't have the cash available... well, your waffle business may come to a screeching halt.
Cash turnover is therefore a fundamental measure of the efficiency with which your company manages cash inflows and outflows, or cash flow.
It can be accelerated by :
- reducing the amount of inventory waiting to be sold (waffles on the tray)
- collecting payments earlier (although Mme Dujardin has promised to pay for the waffles in two months' time, immediate payment would give you the cash you need to expand your business to all the schools in the area, or to start making cookies).
- increase payment times to suppliers (the supermarket can wait a little longer until you pay for the flour - you could be creating jobs, after all!)
If you look at your own business, what does your cash conversion cycle look like? Is it rather short? Rather long? Can you improve it? And if you can, how will you use the cash you free up?
*One of Canada's major Inuit languages, spoken by 38,000 people according to the 2021 census.
