Expense to Profit Conversion Cycle

 

Mo’s Widgets –  Expense to Profit Conversion Cycle

 

                                      Or………..

 

“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.