Latest / Cash Flow Conversations with Fexingo: Working Capital, Receivables, and Small Business Finance / How a Cash Conversion Cycle Audit Reveals Hidden Working Capital
Transcript
- Lucas: Last week I was talking to a specialty coffee roaster outside Portland. They roast about 12,000 pounds of beans a month, sell to cafes and a few grocery chains. Decent margins, growing. But the owner told me she felt like she was always a week away from missing payroll. Luna: That's such a common story. Growing revenue but still feeling cash-poor. What was going on? Lucas: So we sat down and ran a cash conversion cycle audit. It's basically the single most revealing metric for a business like hers. The cash conversion cycle, or CCC, measures how many days pass between when you pay for raw materials and when you collect cash from customers. Shorter is better. Luna: Right. It's like a stopwatch on your cash flow. You want that stopwatch ticking as few days as possible. Lucas: Exactly. We calculated hers. It was 72 days. That means every dollar she spends on green coffee beans is tied up for over two months before it comes back as cash. For a business doing about $1.8 million in annual revenue, that's a lot of capital sitting still. Luna: Seventy-two days. That's brutal. How did she compare to industry benchmarks? Lucas: For specialty food manufacturing, the median is around 45 to 50 days. So she was about three weeks worse. The good news is the CCC is made up of three components you can actually fix. Days inventory outstanding, days sales outstanding, and days payable outstanding. Luna: Break those down for us. Let's start with inventory. Lucas: Days inventory outstanding, or DIO, is how long raw materials sit before they're sold. For her, it was 38 days. That's high for coffee because green beans have a shelf life — they lose flavor after about six months. She was carrying about 45 days of green beans, plus finished roasted coffee in warehouses. She could safely cut that to 28 days without risking a stockout. Luna: So she was basically hoarding inventory. What did she change? Lucas: She switched to a weekly ordering cadence instead of every two weeks. She also negotiated with her main supplier to hold a small buffer of green beans at their warehouse, ready to ship in 48 hours. That alone dropped DIO from 38 to 29 days. The supplier liked it because it smoothed out their production schedule, so they gave her a small discount too. Luna: Nice. Win-win. So that freed up some cash. What about the other side — how fast she gets paid? Lucas: Days sales outstanding, DSO. Hers was 41 days. That's actually not terrible for wholesale food — many cafes pay net 30 but take 45. But she had one grocery chain paying in 62 days consistently. That one customer accounted for 18% of her revenue. She'd never asked them to pay faster because she was afraid of losing the account. Luna: Classic small business fear. What did she end up doing? Lucas: We looked at her contract, and it said net 30. So she was already within her rights to push back. She called their AP department — professionally, not confrontationally — and asked if they could process payments on time because she was investing in new equipment. They said sure, they just needed a reminder. She started sending invoice reminders three days before due date. That chain paid in 35 days the next month. Luna: Sometimes it's that simple. Just asking. But most people don't. Lucas: She also found a hidden leak. She was invoicing only once a week, every Friday. So if a customer ordered on a Monday, that invoice didn't go out for four days. That's four extra days of float. We calculated that a 48-hour invoicing delay was costing her about $1,400 a year in lost interest if she'd had that cash earning 4%. Not huge, but it's free money. She switched to invoicing within 24 hours. Luna: That's a great point. Invoicing speed is a zero-cost way to shrink DSO. What about the third leg — days payable outstanding? Lucas: DPO. How long she takes to pay her own suppliers. Hers was just 11 days. She was paying her green bean supplier on delivery because she thought it built trust. But the supplier offered net 30 terms. She could have stretched to 25 days without hurting the relationship. That alone would add 14 days of float on her largest expense. Luna: So she was giving away free financing to her supplier. That's the flip side of the cash conversion cycle — you want to collect fast but pay slow. Lucas: Exactly. By negotiating to net 25, she increased her DPO from 11 to 25. Combined with the DIO improvement and DSO improvement, her CCC dropped from 72 days to 34 days. That's 38 days of cash freed up. On $1.8 million in revenue, that's roughly $187,000 of working capital that was previously just sitting in the cycle. Luna: That's massive. And she didn't take out a loan or factor receivables. She just changed processes. Lucas: Right. And we should say, this wasn't a one-time fix. She now reviews her CCC quarterly. It's like a health check for the business. If it starts trending up, she knows something's off before the bank account tells her. Luna: You know, this is exactly the kind of conversation that I think is so valuable because it's practical. And it's why we keep this show ad-free. If these conversations have moved your work forward in some small way, listener support is what keeps it that way. Lucas: Yeah, we deliberately don't run ads on these episodes. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. No pressure, just if it's useful to you. Luna: Totally. And now back to the roaster — one more thing she did that I thought was clever. She started using a simple spreadsheet to track her three D's: DIO, DSO, DPO. Every month she plugs in the numbers. She noticed that during the holiday season, her DSO spiked because cafes paid slower. So now she builds a cash buffer in October specifically for that. Lucas: That's the real win. It's not just knowing the metric — it's using it to anticipate problems. The CCC is a leading indicator of cash stress. If you see DSO climb in August, you know November will be tight. You have time to act. Luna: What about businesses that aren't manufacturers? Does the CCC apply to a service business? Lucas: Absolutely. For a service business, DIO is often zero or very low because they don't hold inventory. So the CCC is mostly DSO minus DPO. A consulting firm that bills net 60 and pays contractors net 30 has a negative CCC — they're collecting cash before they have to pay out. That's the holy grail. But most service businesses have positive DSO because clients pay late. Luna: So for them, the leverage point is really DSO. Speed up invoicing, offer small prompt payment discounts, automate reminders. Lucas: Exactly. And for inventory-heavy businesses like the roaster, the biggest lever is often DIO. She cut 9 days off inventory just by ordering more frequently. That's free cash flow improvement with zero cost. Luna: One thing I want to clarify — when you calculate the CCC, you need the right numbers. It's DIO plus DSO minus DPO. But you have to use the cost of goods sold for DIO and DPO, and revenue for DSO. People mix those up. Lucas: Good catch. DIO and DPO use cost of goods sold because they relate to what you're buying and holding. DSO uses revenue because that's what you're collecting. If you use revenue for all three, you'll get a distorted picture. For the roaster, using COGS for DIO gave us 38 days. If we'd used revenue, it would have been 52 days — way off. Luna: So what's the one thing a listener should do this week after hearing this? Lucas: Pull your last three months of data. Calculate your DIO, DSO, and DPO. Then pick the one that's farthest from industry benchmark — or just the one you can improve fastest. For most small businesses, it's either DSO from slow invoicing or DPO from paying too early. Make one change. Measure again in 30 days. Luna: And if you want a template, we'll put a simple CCC calculator on the show notes page. No charge, obviously. This is what we do. Lucas: The roaster saved herself from what would have been a very painful summer. She's now forecasting cash flow six months out instead of two weeks. That's the power of understanding your cycle.