One area startups don’t usually think through is their cash conversion cycle. What I mean by cash conversion cycle is how much work it takes to make a sale, deliver the goods or services, and get paid. At first it doesn’t seem like a big deal. You sell something and you get paid, right? Wrong.
Here’s an example cash conversion cycle:
- Start calling on companies to build a sales pipeline for three months.
- Have an average of a two month sales cycle. Now you’re at five months before the first sale.
- Collect 50% up-front and 50% upon completion, Net 30 days (you give them 30 days to pay you).
- Take 60 days to implement, train, and make the client happy.
- Invoice for the final 50%, Net 30 days.
So, three months of calling, two months of selling, and waiting 30 days to get paid results in six months for your first dollar to come in. Then, two months to implement, and another 30 days to get paid, and it’s three more months after the first payment to get the second. Nine months after you start you get full payment is this example cash conversion cycle.
My recommendation is to think through the cash conversion cycle when deciding on your business model.
4 thoughts on “Cash Conversion Cycle for Startups”
Nice post. That cycle can be Evrn worss for startups especially if you don’t have strong margins or a known product/vendor. Now, try to match the expense conversion cycle to cash conversion cycle 🙂 That makes itveven more fun! An AR LOC, can help with this problem sometimes.
Thanks Dave! Great point that a line of credit or factoring receivables can help with this issue.
David. For a prof Svcs firm it is even more of an issue. Negotiate the deal then the client give you invoicing procedures which is fraught with documentation requirements and multiple signoffs. If the supplier does not learn the “dungeons and dragons” process to get paid, they can exhaust cash quickly. Note to self, know the mechanics of getting paid before you start.