The Impact of Inventory Reduction on Cash Conversion Cycle: Insights from The Hackett Group Survey
In a survey conducted by The Hackett Group, a strategic consulting firm, in 2019, it was found that the largest companies in the United States have achieved their best operating cash flow in six years. This achievement is largely attributed to companies that have reduced their inventory for the first time in almost a decade. The survey revealed that the net working capital of the companies surveyed reached $1.2 trillion, but as a percentage of revenue, it decreased by 2%. This reduction in net working capital frees up cash for other purposes, as evidenced by the study's finding that operating cash flow among the surveyed companies increased by 8% from the previous year. One key metric for assessing the overall effectiveness of working capital management is the cash conversion cycle (CCC). The CCC measures the time elapsed from when a company pays its suppliers to when it receives payment from its customers. Companies extend their CCC when they hold inventory longer, take longer to collect receivables, or pay their trade creditors (suppliers) more quickly. A longer CCC means that companies need more financing to bridge the gap between when they spend and when they collect cash. Therefore, each company has an incentive to reduce its cash conversion cycle. The survey by Hackett found that most of the reduction in the cash conversion cycle was due to three factors. Companies held inventory 1.4 days less and collected receivables 0.8 days faster, but they also had 1.6 days less unpaid debt. These three factors reduced the cash conversion cycle by 0.6 days. The findings of this survey highlight the importance of effective working capital management and the potential benefits of reducing the cash conversion cycle. By optimizing their working capital, companies can improve their cash flow, increase efficiency, and ultimately drive profitability. As companies continue to navigate the ever-changing business landscape, it is crucial to prioritize working capital management and continuously seek opportunities to optimize their cash conversion cycle.