Let’s break this down We measure how swiftly a company turns cash into goods or services and back into cash. To do this, compute the cash conversion cycle, or CCC.

CCC = DIO + DSO – DPO   where:

DIO = days inventory outstanding

DSO = days sales outstanding

DPO = days payable outstanding

DIO = 365*Average Inventory/COGS. Days inventory outstanding is how many days it takes to sell inventory. Shorter is better. The more quickly a company can sell its inventory, the less time that cash is tied up as inventory sitting in the warehouse.

DSO = 365*Average Accounts Receivables/Revenue.  Days sales outstanding is how many days it takes to collect accounts receivable. Shorter is better. Quickly collecting the cash for sales means more quickly putting that cash back to work rather than lending it out to its customers (at 0% interest).

DPO = 365*Average Accounts Payable/COGS.  Days payables outstanding is how many days it takes the company to pay the bills to its suppliers. Longer is better. That is, extending payment of accounts payable acts as an interest-free loan to the company and keeps more cash within the company – until they quit extending terms.

Why does the CCC matter? The less time it takes a firm to convert outgoing cash into incoming cash, the less cash you need to run the profit engine. The less money tied up in inventory and accounts receivable, the more available to grow the company, pay investors, or both. To calculate the cash conversion cycle, add ‘days inventory outstanding’ to ‘days sales outstanding’, then subtract ‘days payable outstanding’. Like golf, the lower your score here, the better.

Example: a small distributor

You can see that, as with most distributors, their cash cycle is balanced as they negotiate terms with their suppliers that let them pay for goods about the time they are able to collect on sales. They’ve pretty much averaged zero days cash conversion over these three periods. In that way they avoid needing large amounts of cash to support their profit engine.

For most small businesses, the CCC can give you valuable insight into how much cash is needed to sustain the business, where it is coming from, and whether or not that is a suitable place. It will also tell you how long it takes to turn a profit into cash. A company that’s taking longer to make cash will need to tap financing to grow faster than its profit reinvestment allows.

Many companies have poor basic capital structures where there is no real source of financing for the needed cash to operate the business, and this needs to be corrected.

Example: a small manufacturer

This firm needs to do work on its policies and operations. Its position improved somewhat over the three time periods, but it still needs to have 237 times its average daily revenue in cash to finance its operation! Mostly this is due to excessively large inventories that are being financed on the back of paying its suppliers very slowly – almost a year on average! – and collecting from its clients very quickly. One look at this would lead us to go look at the inventory to see if it is still useful or if they’ve accumulated a bunch of inventory that will have to be thrown away.

For other firms, especially firms under duress, the CCC can tell you how well the company is managed or, at least, the degree of distress. Firms that begin to lose control of the CCC may be losing their clout with their suppliers (who might be demanding stricter payment terms) and customers (who might be demanding more generous terms). This is an important signal of future heightened distress — one that is key to investors and lenders.

How much capital do I need to operate my Cash Cycle?

You must have come up with the cash to pay for the inventory not when it is delivered, but when the invoice is due. Normally this is 30 days after delivery, but specific to the terms you negotiated with your supplier. Then, to the extent those terms are sooner than it turns into a sale (i.e. DIO > DPO), you need to finance your cost of inventory per day for that number of days. Additionally, you need to finance your receivables balance for the duration it is outstanding.

Where does it come from

Mostly, you’ve built this up from the original investment in the business, and accumulated profits. Conversely, you can borrow against your receivables and inventory assets (on the balance sheet) to finance them. This financing is called a working capital line of credit, or factoring.

What change over time tells me

For a firm in distress or need of capital, I’m highly interested in comparing a company’s CCC to its prior performance. Here’s where I believe all owners, managers, investors, and lenders need to become trend-watchers. Sure, there may be legitimate reasons for an increase in the CCC, but all things being equal, I want to see this number stay steady or move downward over time. Because of the seasonality in some businesses, the CCC for the TTM period may not be strictly comparable to other fiscal periods. Even the steadiest-looking businesses on an annual basis will experience some quarterly fluctuations in the CCC.

Though the CCC is easy to calculate, it’s definitely worth watching every quarter. You’ll be better informed about potential problems, and you’ll improve your odds of finding the right capital structure for your business.

If you want to get really sophisticated, you can add the amount tied up in property, plant and equipment, call that tangible capital employed, set it as the denominator under profit, and see what returns you are earning on the capital you have tied up in the business. Perhaps you’ll find you’d be better off buying a Treasury bond and sitting on the beach.

Cash is King. Profit numbers live in the accounting fantasy world we call “earnings” and have all sorts of things in them. Understand where your cash is coming from and what it is being consumed by and you’ll be a long way down the path of being able to keep some of it for yourself.

When looking for a business loan it is critical to present a professional appearance to potential lenders. Everyone knows to be organized, thorough and courteous, but many make a common mistake that ensures lenders won’t take them seriously. The fix is inexpensive and simple but if you aren’t aware of the problem it can be a costly mistake.

Many business owners underestimate the need for a custom email address for their company. Often, the first piece of information a lender sees about you and your company is an email address. Your first impression should be that you have taken the time to structure your business communications correctly. Sending business correspondence from a free email service like Gmail, Yahoo, or AOL undermines professional image.

Additionally, creating a simple web site to go along with your domain provides an extra edge of credibility. Savvy lenders, partner companies and consumers will check your site. Having a professional site not only shows that you are a legitimate business, but provides more information about your company. Consider it a low-cost opportunity to present your sales pitch to each visitor to your page. Most companies that sell domain names will also provide hosting, and many will set up a simple page for you.

A custom business domain name and email service is easy to set up. Some solutions cost less than $10 a year. Owning your domain shows lenders that you are running an established and legitimate company, and that you plan to stay that way. Take the time to set up a custom domain for your business emails. Start your conversation with lenders on the right note.

(The following services provide simple, affordable solutions for small to mid-size businesses)

• GoDaddy.com – $7.99 a year for most domains, as little as $5 a year for email
• Google Apps – free email accounts for your owned domains
• Yahoo Small Business: $2.91/mo for 1 address

LinkedIn, the most popular social networking site geared towards professionals, has a long-awaited IPO coming soon. Last week, the company filed paperwork with the SEC to officially begin the process of an initial public offering. Currently, LinkedIn is estimated to be worth $2.51 billion, a number that is expected to grow as the company becomes publicly traded.

If social networking isn’t your thing . . . maybe it should be.

Think of LinkedIn as the next step in the evolution of managing business contacts. LinkedIn is to your Outlook contacts, as Outlook was to your Rolodex. Except now, you have access to key introductions that you never knew your personal network had. As a small business owner, you are already strapped for time so adding another thing to your list sounds daunting. Wouldn’t you love to connect with new prospective business partners, customers and employees without having to “meet for coffee” with your entire network to find out who they know? LinkedIn is a resource to find, talk with and influence your industry. As of December 31, 2010, there are over 90 million registered users of LinkedIn. Now that the site has gained traction, it’s time start a free account and reap the benefit.

What can it do for me?

A new business opportunity might be looking – Be findable. Remember the Rolodex –> Outlook –> LinkedIn metaphor? Think of LinkedIn as the world’s biggest Rolodex – and you and your connections are an invitation-only part of it. You personally, your company, me, everyone can be in this giant Rolodex. Some entries are robust and engaging, others are lackluster. Just as a warm introduction gets more traction than a cold call, a thoughtfully prepared LinkedIn profile with a robust group of connections will help you attract the contacts you need.

Keep in mind people are looking at your “Rolodex entry” as a summary of your career and as way to non-intrusively connect with and learn about you, even if they do not have your email address (The LinkedIn message system includes inter-network message sharing). Even when your contact information changes over the years, people can easily find you without your email address and vice versa. Personally, I don’t consider myself prepared for a phone call or meeting until I have done my Linkedin homework. My link: www.linkedin.com/in/sandrachesnutt

Link to the right person for the job. Talented job seekers now actively use the extended LinkedIn network and LinkedIn Jobs module (www.LinkedIn.com/jobs) – at all levels. Searching for new employees through LinkedIn gives the added bonus of allowing you to investigate a candidate’s connections, work experience, and to an extent their character, conveniently displayed within their LinkedIn profile. We have found some of our best hires directly through Linkedin.

Get free PR. As easy as it is for you to use LinkedIn to size up job candidates, you can be sure potential partners, employees, and contacts are sizing up your business. If you are nowhere to be found, what does that say about your business savvy and industry presence? Make it easy for people to get the correct message about you – from you.

Become an Influencer. LinkedIn also gives small businesses the opportunity to engage prospects on the same footing as larger businesses. Forget press releases and outsourced public relations. Participating in and guiding industry-focused discussions on LinkedIn is an affordable and credible way to build your brand.

Begin discussions and give insight that is meaningful to your business. You can impact your client’s, prospect’s and potential employee’s awareness of you. Try searching LinkedIn Groups for discussions related to your business or industry. One caution, don’t seek attention. Being annoying is one way to make an impression and improve stickiness, but certainly not the one you wanted!

Finally, you can’t afford not to participate in LinkedIn. Ignoring LinkedIn reduces your company’s ability to make impressions on your targets. And we all know, out of sight, out of mind.

Recently, I spoke with a professional collections representative, Frances Robinson, to find out the secrets behind effective collections calls. As background, you should know that Frances, who has been in the collections industry for 17 years and has lead our collections team for three years, is well known at AdvancedAR for her kind and gentle spirit.  Here are some nuggets of wisdom from our conversation:

Sandra: What is it like to call someone at a business about payment when you know that they are busy and not going to be excited to get your call?
Frances:  Regardless of the industry there is a common phrase that is universal in the world of collections, “The check is in the mail.” Unfortunately, in many instances the invoice has not even been scheduled for payment, and this line is simply a way to get the collector off the telephone with a promise to pay.

Sandra:  I bet you hear that frequently. And I wouldn’t be surprised if that promise is routinely broken. How do you respond?
Frances:  The key to successful collections is to not take the broken promise so personally that it alters your personality, speech, and professionalism on the follow-up call. It is beneficial to maintain a firm but respectful tone during a collection call. This allows you as the person seeking to be paid to take control of the call and to stress the importance of making your company’s debt a priority without insulting the customer.

Sandra: How do you make sure that your phone call gets results?
Frances:  As I have heard often, it is easier to draw bees with honey than vinegar. The same is true with collections. When a collector treats a debtor with respect, most of the time your invoice is placed closer to the pile of invoices scheduled to be paid.

Sandra: What philosophy have you developed from over 20 years in professional B2B collections?
Frances:  My philosophy has always been to treat people the way I want to be treated. Each call and circumstance is different. A collector may be speaking to a customer experiencing temporary financial problems one month, and enjoying a flourishing business the next month.

Sandra: What’s changed about collections since you first began?
Frances:  Although we are living in an electronic era, one factor remains the same in collections, often the check is actually in the mail, and past due invoices will be paid with follow up and a firm, but respectful, collection call.

What are your collections secrets?

Sandra Chesnutt is a Marketing Director with AdvancedAR.   She spoke with Frances Robinson, a valued AdvancedAR associate who makes collections calls as part of the AR services provided by AdvancedAR.  AdvancedAR combines professional receivables services with fast and affordable access to funding – providing small and medium businesses the cash they need to grow and take advantage of market opportunities.

There are several strategic ways to go about this:

Reducing days sales outstanding (DSO).  In my last blog, I talked about how to calculate the valuable DSO number.  The most important thing you can do is start measuring your DSO regularly and consistently.  Decreasing your DSO can free up more cash than you realize.  Increases in your DSO can mean your customers are less satisfied than they were before.  UPS, the shipping company, calculates DSO by customer.  If they see a downward trend they immediately make a customer service call.

Your AR department is your most important customer service team. They are always dealing with your customers’ money and people are sensitive about money, even in a business situation.  Developing the skills within your organization to take the emotion out of the AR process improves customer service.  Every aspect of the sales cycle from order to collection is influenced by customer service.  Recurring sales are often influenced by customer relationships; your AR department can cost you if it is not professionally monitoring and managing collections and customer relations.  More often than not, the small business owners we talk to feel they should make the collections calls themselves.  We feel that this is not a best practice – more about that in an upcoming blog.

Carefully reevaluate the assumptions behind your AR to collections policies. You may never make collections calls before 60 days because you assume your customers will be offended if you follow up before then.  Would your aging improve if you made calls at 15 days to verify receipt of the invoice?  Most non-payment is due to a dispute. The sooner you know about disputes, the more quickly they can be resolved, reducing the negative impact on your cash flow.  What other assumptions are keeping you from successfully converting receivables to cash effectively?

Get creative. You know your business better than anyone.  What can you do to decrease accounts receivable overhead and processing costs?  Can you standardize price lists and proposals?  Are you requiring written quotes?  Can you standardize collection strategies by type or value of customer?  Are you able to process alternative forms of payment?  Is there any way to reduce sales cycle time?

Improving your AR management can lead to significant financial gains, something everyone wants for Christmas.

Without boring you like Charlie Brown’s teacher, I will explain why knowing it can ultimately help you improve your cash flow in the future and, then, let’s get to the meat of how this little equation works.

Why do you care about DSO?

When used consistently, this calculation can help you answer a variety of questions such as:

• What is the effectiveness of my credit and collection policies?
• Are my credit terms in line with competitors?  The Credit Research Foundation (CRF) does a quarterly study, the National Summary of Domestic Trade Receivables (a.k.a., the DSO Survey), that is an examination of the condition of AR for U.S. companies. The results of the complete study are available to CRF members and those participating in the survey.
• Are my collections procedures successful in meeting my goals?
• Is my customer base risky?
• What is the real reason for the changes within my receivable balance?  Was it a fluctuation in sales during that period, or are promotional discounts, seasonality or selling terms making the impact?

Unleash the DSO.

Days Sales Outstanding expresses the average time, in days, it takes your company to convert its accounts receivables into cash. There are several ways to calculate DSO.  Each method for calculating DSO (outlined below) has its own strengths, and each is based on what might be called the Standard DSO formula. The key to making effective use of any of these tools is consistency.  Select the method s that work best for you and stick with them.

• The Standard DSO calculation provides an average (aggregate) time in days it takes to convert accounts receivables into cash. It should be tracked over time and compared to previous company results or industry/competitor benchmarks

DSO = (Ending Total Receivables / Total Credit Sales) x Number of Days in Period

• Best Possible DSO utilizes only your current (non-delinquent) receivables to calculate the best length of time you can achieve in turning over receivables. It should be compared to the standard calculation above, and be close to your terms of sale. The closer your standard DSO is to your best possible DSO, the closer your receivables are to your optimal level.

Best DSO = (Current Receivables / Total Credit Sales) x Number of Days

• True DSO calculates the actual number of days credit sales are unpaid by tracking individual invoices to the month of sale.

True DSO = (invoice amount / net credit sales for the month in which the sale occurred) x number of days from invoice date to reporting date

Of course, if your DSO shows it is time to reign in those receivables, there are several strategic ways to go about this.  We’ll delve into that next week . . . to be continued . . .

By Dan Drechsel

It’s common for small businesses to slip into bad habits that limit their ability to get funding.  From unscreened customers to generous payment terms, here are some of the most common reasons lenders will not loan to small business owners.

1. Not putting profits back into the business

When you hear these pleasant words from your accountant, “You should take a draw before the end of the year,” think again.  Building equity in your business has a positive impact on your ability to get funding.  A lender always looks at your debt-to-equity ratio.  The more equity you have, the better your ratio.  If you believe you will be able to grow the business next year, and will need financing to make it happen, manage your debt-to-equity ratio as carefully as you manage your personal taxes.

Good habit:  Keep your business solid by re-investing to support growth.

Check out Dan Drechsel’s entire guest blog article by visiting: http://www.smbceo.com/2010/11/29/bad-habits-funding/ on Small Business CEO.

Often, small business owners will ask why lenders require them to sign a personal guaranty, especially when the lender also requires the business to pledge all or substantially all of its assets as collateral. The reasons are somewhat inter-twined, but the short answer is that it is a function of risk and the fact that most small businesses are also closely held and controlled.

As a rule, small businesses are riskier ventures than large businesses. In fact, the failure rate and default rate of a business increases as its size decreases. Said another way, size does matter. This is one reason why the lender will require a backup or secondary source of repayment in the form of a PG.

Another reason is that the small business is often closely held by one person, a family or several partners and is therefore simply an extension of the owner(s) and their lifestyle. The owner has absolute control of the business, being able to affect all decisions that impact the success or failure of the company, including strategic direction, policy making, management, capital structure, asset sales, liquidation and owner’s compensation. A PG is a show of confidence by the owner that the decisions being made are with an eye toward being sound financially and with the interests of creditors also in mind.

Finally, when a small business is no longer viable, the lender and other creditors are more likely to be repaid if the owner remains actively engaged in the orderly wind down or liquidation of the business. The owner can maximize asset sale or liquidation values as opposed to “throwing the keys to the bank.” The lending community often refers to this phenomenon as “aligning the interests of the owner with those of the lender.”

A logical follow up question is what needs to happen to negate the need for a PG in a small, closely held business. The short answer is that it probably won’t happen as long as the business remains small and closely held, given the reasons above. However, at some point lenders will not require a PG and factors influencing this decision are not only size and ownership structure but also the financial wherewithal of the company, collateral coverage, and depth and breadth of the management team. While not a true substitute for a PG, lenders may rely on financial and other covenants, as well as, asset based lending arrangements to control their lending risk. It is generally accepted in the marketplace that lenders will require PG’s on all closely held businesses and that getting a lender to move off this requirement becomes less likely the smaller and more closely held the company is.

To summarize, PG’s will be required from the controlling owner(s) in most all cases where you have a small, closely held business for the simple reasons that smaller businesses are generally riskier than larger ones and that the small business is considered an extension of the individual controlling it and therefore that person should be financially responsible for it. In the event the business suffers financial distress or fails, the continued involvement of the controlling owner in facilitating an orderly wind down or liquidation of the business generally results in a more favorable outcome for the creditors.

*A personal guarantee is an unconditional promise to pay, made by the individual owner, in the event of default or the inability to pay by the business.

Jeff Guldner has over 30 years of experience in credit risk assessment and management for major lending institutions. Guldner is the Chief Credit Officer for Ftrans. Ftrans combines accounts receivable management with affordable access to funding – providing small and medium-sized businesses the cash they need to take advantage of market opportunities and grow.

Surviving in today’s economy is dependent upon one thing: getting paid.   Many small to mid-sized B2B companies are failing not because of a decline in sales, but because they do not have the cash-on-hand to survive if their customers fail to pay. In this economic climate, business owners have to plan for the worst in terms of their own finances, as well as take their customers’ financial situation into consideration.

It generally takes a small business 56 days to get paid by its customers. For a company selling $20,000/week, that’s eight weeks of sales outstanding, which equals $160,000 in untouchable assets. What would the difference be for a company of this size if, instead of risking that amount, it could have guaranteed access to 90% of that capital within 3-4 days rather than 7-8 weeks?

The economic crisis has affected almost every sector of the US economy but there are a few steps B2B companies can take to protect their businesses from losing money this year.  Business owners should take into consideration the credit worthiness of their customers before making sales and have a backup plan in place to prevent a loss in revenue from buyer bankruptcy. In today’s market, it’s important to understand the consequences of the business relationships keeping a company afloat and although it’s possible for companies to grow under these circumstances, having an added layer of protection certainly helps.

One increasingly popular way for SMBs to protect themselves from being subject to a customer’s failure to pay is by AR Outsourcing.   Here’s some background on how AR outsourcing works and the implications it could have on the health of a company:

Know Who Your Customers Are

Business that use AR outsourcing should implement an underwriting and credit verification process before verifying invoices so that businesses immediately have a transparent look into the creditworthiness of their customers. As a business owner, having this insight helps you avoid selling to someone who might not pay on time – or at all.

A business’ credit management provider should also maintain an ongoing credit monitoring system with its customers to help establish a credit policy that includes trade credit limits and payment terms. Having an understanding with customers about the extent to which you will lend helps ensure a healthy business relationship and protects against unpaid invoices.

Put the Burden on Someone Else

Similar to a B2C company accepting a credit card for payment, AR outstourcing puts the invoicing burden on the credit provider. By working with financial institutions, the credit management vendor borrows against your AR, takes on the debt and provides you with the capital upfront. In some instances, businesses get paid in as few as four business days, which eliminates the hassle of slow paying customers while also increasing a business’ cash-on-hand.

Businesses Have More “Insurance”

By outsourcing AR, businesses are often guaranteed a certain percentage of each sale, thus providing “insurance” for their invoices. In addition, in the event that a customer does go bankrupt, the business is protected and will still get paid. For certain credits, credit insurance backs each sale for up to 90-100% of the amount of the sale made.

By: As founder of FTRANS, John B. Hayes brings over 30 years of experience in developing technology-based companies that help businesses manage their finances.  John was also co-founder and president of the company that built Peachtree Software products, the first microcomputer accounting software.  He recently published a book entitled, “Use the Credit Crisis to Grow Your B2B Business: A Proven Strategy for Enduring Competitive Advantage and Business Growth, Especially in Times of Crisis or Recession.”

 Ftrans combines fast and affordable access to funding professional with receivables services – providing small and medium businesses the business line of credit they need to grow and take advantage of market opportunities.  Liberating you from funding challenges and receivables hassles.