PEOPLE & OPINIONS
Cash Conversion Cycle: Creating a formula for success
Here’s how to unify the D-Suite of O’s by Judi Proctor, Senior Supply Chain Consultant, Vizient
I
n early 2020, I was working in a hospital with the supply chain staff as part of a standard review of their inventory spend. Fast forward six months when the world was well into the COVID-19 pandemic, this same hospital’s inventory spend had escalated by 10 times the original amount.
This was not an isolated occurrence; it happened in many hos- pitals across the United States that were proactive in obtaining personal protective equipment (PPE) and other needed supplies during the pandemic. Products became scarce as hospitals across the nation stockpiled.
Another unforeseen consequence of the pandemic was the dearth in elective procedures. These procedures were cancelled or delayed for several months in 2020 to have the capacity, PPE and other supplies as well as staff to treat COVID-19 patients. Today, delays are still ongoing, and the cancellations have led to an overstock of items, which creates the potential for expiration on some devices. Healthcare organizations are now in a difficult position with excess inventories (working capital) of certain supplies, such as catheter/balloons, endo mechanicals and suture, and custom procedure packs in storage, and an uncertainty of elective pro- cedure patient volume coming back to pre-COVID levels in the near term. To get beyond this scenario and improve management efficiency, liquidity and overall financial position, organizations can use a metric called the cash conversion cycle (CCC). The supply chain has a role to play in this effort.
Do the math: How to calculate your CCC Traditionally, healthcare facilities measure liquidity by these ratios: quick, current and days cash on hand.
• Quick ratio = liquid assets/current liabilities • Current ratio = current assets/current liabilities • Days cash on hand = annual operating expenses/365 These are useful metrics, but they are static. While the current ratio assumes the sale of inventory to pay cur- rent liabilities, the quick ratio excludes inventories, and neither speaks to the time element. Days cash on hand only looks at avail- able cash and does not consider the inventory/working capital. To incorporate the element of time and focus on inflow and outflow of dollars, as well as the timing of those inflow and outflows, you need to use the cash conversion cycle or CCC. The CCC improves the efficiency of management—how to manage inventory, receivables and payables—and can improve cash on hand by providing visibility to the finance department for areas that need improvement. The CCC provides a measurement in days of product cycles, beginning with inventory purchases, moving on to utilization for patients, patient billing processes, payment to suppliers, and finally, receipt of cash back into your facility. It is typically calcu- lated on a quarterly basis—the most recent average for publicly traded healthcare companies is about 30 days. The average for all hospitals, pre-pandemic, was 64 days, according to research recently published by Soumya Upadhyay, Bisakha Sen, Ph.D., and Dean Smith , Ph.D., in the Journal of Health Care Finance. To calculate the CCC, you need three activity ratios: days inven- tory on hand (DIO), days payable outstanding (DPO), and days receivable/sales outstanding (DSO). • DIO = 365/turn ratio • DPO = accounts payable/ (cost of sales/no. of days) • DSO = (accounts receivables/net credit sales) x 365 • CCC = DIO + DSO – DPO.
When it comes to the ratios needed to calculate the CCC, obvi- ously Supply Chain has control over DIO, but it also has some control over DPO. How? When supply chain negotiates the payment terms and conditions of a contract, it forges a direct link to DPO.
Strategies to optimize your cash conversion cycle
A decreasing or stable CCC is a positive metric for the direction and financial stability of an organization. Inventory with a lower turn rate will increase the CCC; inventory with a higher turn rate will decrease it. There are many different strategies that will improve the days of inventory on hand, and they should be regularly reviewed and re-implemented when necessary to manage the turns and thus DIO. Some of these strategies are: • reducing inventory variability, for example, by reducing the number of stock-keeping units (SKUs) in product categories.
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• increasing consignment inventory with vendor-managed inventory.
36 October 2021 • HEALTHCARE PURCHASING NEWS •
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