As discussed in the previous post, AP is often viewed as a cost center and Treasury, in conjunction with AP, is key to establishing the link between corporate goals and AP’s role.

What are some of the financial goals related to AP? Do we care more about days payable outstanding (DPO) or working capital? Are we concerned about liquidity or some other departmental metric? Do we need to make a distinction between measurements that focus on efficiency and those that emphasize financial return and profitability?

Treasury understands that each of these items impact the working capital results. Accordingly, their stake in the success of AP is high.

CashConversionCycle

  • DPO and Liquidity. Month-end numbers and liquidity needs.
    • MEASURE OF EFFICIENCY. Cash Conversion Cycle (CCC). The CCC is a measure of efficiency. It helps us understand how quickly an organization can secure inventory, turn it into finished goods, sell the goods and convert the sale into cash. This covers DI (days of inventory) DPO (days payable outstanding – which covers your efficiency of stretching out when you pay for the inventory) and DAO (days sales outstanding, which measures how quickly you can collect on what is owed). For all organizations, even those without inventory, efficiency in the CCC process provides a helpful measure for organizations to determine how well they are running their operation. It is a measurement in days of efficiency.This measurement also gives a good indication of their ability to handle increases in volume and other organizational changes. An inefficient CCC means more financial capital than necessary may need to be deployed into A/R and inventory. This can seriously obstruct a firm’s working capital metrics over time.
    • MEASURE OF FINANCIAL REQUIREMENTS. Net Adjusted Working Capital (NAWC). Working capital has two formulas. The traditional formula is current assets less current liabilities. This is a measure of liquidity that bankers and accountants enjoy. It provides a general guideline that the more this number is positive, the more likely the organization can pay their current bills as they come due. This measurement is effective for that purpose.The alternative formula is inventory plus accounts receivable less AP. This is a measurement of the financial capital that is used and provided by the business processes that we see operating in the cash conversion cycle. It is a measurement of amount of capital needed for operational activities.

Understanding these measurements is key to driving successful working capital management practices that impact not only the success of AP but of the organization as a whole.

Posted by Craig Jeffery

Craig Jeffery, Managing Partner of Strategic Treasurer, has 20+ years of financial and treasury experience as a practitioner and as a consultant helping organizations craft realistic goals and achieve significant benefits quickly.