Sign & Digital Graphics

April '20

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5 4 • A P R I L 2 0 2 0 • S I G N & D I G I T A L G R A P H I C S be just a few days. In today's market, it is common to extend credit terms of net 30 days. In that case, a company would be doing well to keep its DSO under 40 days. By the way, and not by accident, the business in our example enjoys a healthy 50 percent gross margin since it is gen- erating revenue of twice what it costs to produce the goods. Holding Onto Your Cash To complete the cash-conversion cycle calculation, subtract the days pay- ables outstanding (D P O )—a.k.a. the number of days you hold on to payment to vendors from whom you've bought things—from the combined DIO and DSO. Here you will need the average daily cost of goods sold from the DIO exam- ple above and the amount of accounts payable (AP) from the liabilities side of your Balance Sheet. Since we know the average daily COGS is $822, we will use that figure. Because the fictitious business in our example has an excellent credit rating and has mastered the art of paying pre- cisely on time, all the time, its balance sheet reports an accounts payable total of $20,000 at year's end. What that means is the company's DPO is 24.3 days. Check out the calculations: DPO = Accounts Payable ÷ (Annual COGS/365) = $20,000 ÷ $822 = 24.3 days. Putting all the pieces together, we find that the business in this example has a cash-conversion cycle of just over 26 days. CCC = DIO + DSO – DPO = 30.4 days + 20 days – 24.3 days = 26.1 days. This kind of mastery over a business's accounting practices may be phenomenal and even rare... but it is not unrealistic. Being able to turn the cost of doing busi- ness back into cash inside of a month's time doesn't happen through dumb luck, though. It takes discipline and smart business acumen. Finally, it's not as important to know what your CCC is only for today as it is to know what direction its headed. If DIO and/or DSO creeps up, the cash con- version cycle is surely to rise. Treat your CCC as you would any bodily medical test result (e.g. blood pressure, total cho- lesterol, blood glucose, etc.) You wouldn't just take one measurement and then not monitor it ever again—particularly if one of the results were in an unhealthy range. Keeping it Current As a business owner, the more you become comfortable with and remain aware of your com- pany's cash-conversion cycle and its fluctuations, the more you will make day-to-day decisions that help increase revenues, min- imize inventories and accounts receivables, reduce cost of goods sold and manage accounts payables. Cash-conversion cycle is not the whole story, but when you couple it with your company's current ratio, your business focus becomes razor-sharp. The current ratio provides a snapshot of short-term liquidity because it simply takes the current assets—mostly com- prised of cash, receivables and invento- ries—and divides them by the current liabilities—things like short-term debt, the portion of long-term debt that is currently due, accounts payable and any accrued expenses that have been set aside for future payment (i.e. taxes). It sounds more complex than it is. All you really need to do is consult your con- solidated balance sheet and find the two figures. The formula is simple: Current Ratio = Current Assets ÷ Current Liabilities Ideally, this calculation should fall within a range from 1.5 to 3.0 for a healthy, well-run American company. The current ratio is a quick way to mea- sure how nimble a business can be in the event of unexpected circumstances. In other words, a company would be far bet- ter prepared to deal with a product recall or rash of rejected and returned goods if it had a current ratio of 4.0 rather than a ratio hovering around 1.0. Making it Happen... Now You would expect a business that can convert its expenditures back into cash in 26 days to have a great current ratio. When we consult the balance sheet for the company in our example, we discover the following: The current ratio here is 2.5—not bad, but not as good as it should be for a company this size. In this case, a wise business manager could zero in on a pro- gram to reduce the debt exposure and beef up the current ratio. Hopefully, this will inspire you to retrieve the financial statements of your business and perform the calculations for your own situation. I would recommend that you measure your cash-conversion cycle and current ratio every month— using rolling three- to six-month fig- ures—to see in what direction they're trending. A simple graph over time will provide you with encouragement and a reward for efforts made to reduce the cash-conversion cycle and improve the current ratio. Conversely, the same graph can act as a wake-up call long before your business ventures into financial hot water. Good luck. SDG Cash and cash equivalents . . . . . . . . . . . . .$10,000 Accounts receivables . . . . . . . . . . . . . . . . . 33,000 Inventories . . . . . . . . . . . . . . . . . . . . . . . . . 25,000 Current Assets . . . . . . . . . . . . . . . . . . . . . $68,000 Short-term borrowings . . . . . . . . . . . . . . . . $4,200 Accounts payable . . . . . . . . . . . . . . . . . . . . 20,000 Current portion of long-term debt . . . . . . . . . 3,000 Current Liabilities . . . . . . . . . . . . . . . . . . . $27,200

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