Mo’s Widgets – Expense to Profit Conversion Cycle
“It takes me HOW long to turn an expense into a profit???
Mo’s inventory average is $75,000
Mo’s has to pay his suppliers in 30 days when he buys.
Mo sells to his customers and it takes them 60 days to pay MO.
Annual Revenue $500,000
Cost of Goods (60%) $300,000
Operating Expenses $110,000
Profit for Mo $ 90,000
Mo’s Cash Conversion Cycle
Mo buys a widget for $300 that he will sell for $500. Gross profit $200, nice!
June 1 – Mo buys the widget.
July 1 – Mo pays his supplier $300.
June, July, August – the widget sits in Mo’s warehouse (remember his average inventory is $75,000 and his annual cost of goods is $300,000 ….$300,000/$75,000 = 4 …which is how many times per year Mo turns his inventory. 4 times per year is once every 3 months)
September 1 – Mo sells the widget to Jack’s Stuff, Inc.
November 1 – Jack pays Mo for the widget.
Mo’s cash conversion is 120 days. Mo paid for the widget on July 1 and Mo got paid by Jack on November 1.
Question- Who pays Mo’s employees, rent, phones, etc. during this period?
Answer – Mo’s working capital, which he better have enough of or Mo will be out of business.