TOP 25TH PERCENTILE IN YOUR INDUSTRY MEANS….

…better employees, more sales, less debt, lower inventory, faster collections…fill in the blank as to what it means to you to be so very good. Look, there is a simple truth for every business that exists. You make more money by being BETTER. The “more better” you are (really bad English) the more money you make.

This truth may be simple but improvement takes considerable effort. We know that because only 1 of 4 companies succeed at being in the top 25% at any particular time. (At this point if you are saying “hey, how does he know that?” then just pass on the rest of this blog as you may be skeptical all the way through.) Our intent here is to make these issues clear; as black and white as possible.

In the next few blogs we will take a look at what different businesses experience in the top 25%. We’ll look at what it means to have a business running better in a particular area than 75% of their peers. Hard numbers will be used and inferences extrapolated from it. Some of the numbers will excite you and others will really make you think about “how can we get there from here?”

In reality please remember that everything is held “in tension.” This means that a company could be in the top 25% of “cash on hand” but it could mean they have just borrowed a lot of money and they are uncompetitive because they must make higher debt payments. It is this tension then that requires the considerable effort mentioned in the 2nd paragraph. Let’s take a look at a real situation.

On June 30, 2008, a health products store with an exceptional web presence was at the top 23% of their industry (a comparison group of 345 companies) in cash liquidity. Nice huh? Plenty of cash, receivables, and inventory in comparison to their payables. A banker would be happy to give a loan to this company based on their ability to sell inventory, collect receivables, and use their cash to pay down their payables. More then enough…shoot, they were in the top 23rd percentile of their industry in liquidity. Would you like to be?

Maybe that would be good but there is a hidden story here. One you will definitely not want to miss. Here it is. They were also at only the 46% of their cash conversion cycle in comparison to their peers. Do you know your CCC? This cash conversion cycle is a simple concept but may hold enormous power over your company. What is it? Why does it register poorly when there is so much liquidity in the company?

The CCC is actually a measure of the number of days your cash travels first away from you and then back to you. It answers the question “From the time you give a dollar to your vendor how long before you get it back from your customer?” The answer is listed in number of days and explains why people may not pay on time or contracts are written so someone holds the inventory longer or why you may never have money in the bank but are profitable.

To capture the meat of this issue we need to go back to our friend in the health food business. The median CCC of the industry was 12. This means that if our friend was average his payment to vendors would return to him, from his customer, in just 12 days. Would you be happy to need to finance only 12 days’ worth of your business to be able get the profits you get? Amazingly those in the top 25% were not financing any days! They were receiving money from their customers 18.8 days BEFORE they had to pay vendors, employees, expenses, etc. Would that help you? Would your business run differently if you had more cash on hand…all the time? What would it be like to borrow less, worry less, and have more to invest back into your business?

At this point we do want to know the outcome for the health food business. What is the reality of that entire inventory we are so happy to have on our balance sheet. How about that marvelous cash on hand? By the way that was from a long-term loan he had to take out. Well, you say he must be really glad he was paid up with his venders. Not so fast. It is the accounts payable, the inventory, and the receivables that all lead to him having a 33.1 day cash conversion cycle! Twenty days longer than the norm.

Yes, he can pay his payables with all his receivables and remaining inventory and that is nice for the bank who wants to be sure that the businesses’ loan payments can be met. Trouble is if he had been in the top 25th percentile of CCC he wouldn’t be on C.O.D. with his vendors and he would be delaying payment to them according to industry standards. By delaying vendor payments he would have shortened the CCC so receipts from customers would be closer to the time he put out a dollar. See where this is heading?

What is your Cash Conversion Cycle?