Managing cash flow is an essential consideration for business success. Cash flow as it relates to working capital is particularly important for two sectors that see their sales peak in the fourth quarter of the year: manufacturing, and wholesale and retail.

Businesses in these two sectors would have already seen an increase in sales in October and during the first weeks of November. Therefore, the large amount of inventory tied up in working capital prior to October has declined and is shifting to receivables. An important consideration is that these sales need to be converted from receivables back into cash – until the money from a sale is paid into the bank account of the business, this cash is tied up as working capital. Importantly, when cash is locked up in the sales process, it cannot be used anywhere else in the business. An added complication is that many businesses are closed for the December holidays and some manufacturers and wholesalers and retailers may see delays in their usual collections cycle.

The cycle of turning a company’s cash investment in inventory back into cash (from sales of that inventory) is known as the cash conversion cycle. The longer this cycle, the greater the amount of capital invested in the sales process. The cash conversion cycle also takes into account the amount of time it takes a business to pay its suppliers (the payables payment period). Some retailers stretch the payables payment period to the extent that it is longer than the sum of the days that money is tied up in inventory processing and receivables collections. In these cases, the company’s payables are funding the short-term working capital needs of the business. If the cash conversion cycle is greater than zero days, the capital tied up in this cycle will need to be funded by some form of short-term finance (in the form of cash or a facility such as an overdraft).

The above table features an analysis of ten years of annual financial statements, representing about 40 000 statements for businesses in the manufacturing and wholesale and retail sectors.

On average, these manufacturers keep inventory longer, take longer to collect receivables but also take longer to pay suppliers. This equates to cash tied up in the cycle for an additional 17 days, compared with the wholesale and retail businesses analysed.

Let us use a proxy for the short-term funding required as daily credit sales multiplied by the cash conversion cycle (see table below).

If we assume the same customers have average daily sales of R1-million and 50% of these are on credit, the average funding needs are about R28.5-million and R20-million for manufacturers and wholesale and retailers respectively. Remember, though, that, in the fourth quarter, a greater percentage of sales occur; therefore, this need for funding would jump to about R31-million and R22-million respectively. What if it took a week longer to collect receivables because of finance departments being closed over this peak period? The approximate amounts would jump to R35-million for manufacturers and R26-million for wholesale and retailers.

While both sectors see peak seasonal sales in the final quarter of the year, the composition and duration of their cash conversion cycles vary. It is not only the elements of the cash conversion cycle that are important for business owners at this time but also how they fund the capital tied up in this process. While sales and margins might be under pressure in the current environment, managing the cash conversion cycle (and how quickly money comes back into the business) is critical in ensuring that there is sufficient short-term funding to operate the business successfully.