How Construction Companies Can Improve their Cash Conversion Cycle
As a small business owner, it’s essential to understand the cash conversion cycle (CCC) and how it impacts your company. This metric looks at the number of days from when you first purchase materials until you receive payment from your customers.
Unfortunately, for most construction companies, lowering this number is an ongoing challenge. APQC found that the bottom-performing companies have a CCC of 74 days or longer.
If you’re looking for ways to improve your cash conversion cycle and free up working capital for your business, a business charge card can help.
What is the Cash Conversion Cycle?
The cash conversion cycle tracks the amount of time it takes to convert inventory (or project materials) into cash. In other words, it measures the amount of time it takes to:
- Purchase supplies
- Turn those supplies into a completed project
- Collect payment from your customer for that project
The lower your cash conversion cycle, the better. That’s because a lower CCC indicates that your company has a fast materials-to-sales pipeline. A high CCC means your business takes a long time to convert inventory to cash.
The cash conversion cycle is influenced by what payment options you offer to your customers and how long it takes you to collect payment. It’s also affected by how your company chooses to finance its purchases.
Why Construction Businesses Need to Understand the Cash Conversion Cycle
The cash conversion cycle is a metric all companies should be tracking, but it’s especially important for construction companies. That’s because most construction companies have to invest a lot of upfront cash before they can secure new projects.
And once they do land a new project, the company will have to invest in additional materials and supplies. Then it may be necessary to sit on those materials for months while delivering on a project for a customer.
There is no option for Just-in-Time inventory, and current supply chain issues only exacerbate this problem. These factors put a strain on the cash conversion cycle and can lead to serious cash flow issues.
Construction companies that have learned to reduce their cash conversion cycle have more cash on hand and can therefore take on more projects and grow their businesses faster.
The Problem With Poor Cash Flow Management
On the other hand, if your CCC is too high, you may end up with a growing business that can barely stay afloat. It's easy to think that high revenues can solve all business problems, but cash flow management is actually more critical.
Businesses with poor cash flow often struggle with the following issues:
- Struggle to pay bills: If you frequently run into cash flow problems, you probably have a more challenging time paying your bills each month. Companies with cash flow issues often struggle to meet payroll and pay their suppliers and vendors on time.
- Poor credit: Cash flow issues can also make meeting short-term and long-term financial obligations more difficult. Frequently missing payments can negatively impact your company’s credit rating.
- Less competitive: Cash flow problems make it harder to invest strategically in your company. That’s because you always have to make decisions based on what will lead to the most money right now and can never think about your company’s long-term growth. Failing to invest will make your business less competitive in the long run.
- Potential for going out of business: Companies with cash flow problems are at a higher risk of eventually going out of business. One study found that 82% of businesses fail due to cash flow problems.
How a Charge Card Can Help Your Cash Conversion Cycle
Using a charge card can help free up cash flow and improve your cash conversion cycle. Here are four ways it does this:
- Free up cash flow: When you run a construction company, there’ll inevitably be gaps between when a new project starts and when you get paid. A charge card can help you continue to pay vendors and other bills while you’re waiting to get paid by clients.
- Higher spending limits: Most charge cards have higher spending limits than typical credit cards, giving you more flexibility when making purchases. This gives you the ability to fund larger projects while you’re waiting to get paid. But it doesn't mean you can spend whatever you want — your spending power adjusts from month to month depending on your company's cash flows and how you use the card.
- Earn rewards for your business: Most charge cards come with generous rewards that can be applied towards business purchases. You can earn travel, cashback, and rewards points, which can be used to increase your business's purchasing power.
- No interest: Because charge cards are paid off in full each month, they don’t come with any interest charges. How does interest affect your CCC? Every dollar of interest payment you make actually increases the effective cost of your materials. This not only means that you now need to charge higher prices to your clients to make a profit, but it also increases the effective number of days it takes your company to turn a dollar of spend into profit.
The Bottom Line
The cash conversion cycle is a vital metric of the health of your business. If customer payments come in too slowly, your business could struggle to meet its ongoing financial obligations.
A charge card can be a great way to turn things around and improve your CCC. That’s where Toolbox can help — our 30-day corporate charge card is designed to meet the unique needs of construction companies.
The application and approval process takes as little as one day, and we’ll never ask for a security deposit or personal guarantee. So contact us today to start the prequalification process.