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A cash conversion period is the amount of time that passes from the time that a sale of a good or service is made and when the cash is actually received for the product that was sold. Within the scope of this period is the process of the customer buying the product, the time that it takes to prepare and send an invoice to the customer, and how long it takes for the customer to remit payment and the recipient to record the payment it the accounts receivable section of the company’s accounting books. One school of thought takes the period a little further, considering the starting point to be when the salesperson initiates the customer contact that leads to the sale, although this is not always a consideration.
The idea of identifying the cash conversion period is to get some idea of the time lag that occurs between the use of company resources and when the company actually receives a return on those efforts. Identifying the elements or events that occur during the period makes it possible to develop a reasonable time line and have a good idea of when payment is most likely to be remitted, allowing the company to make use of that collected revenue. At the same time, identifying and evaluating each process that occurs during the cash conversion period can often aid in finding ways to expedite the receipt of the payment, shortening the time lag between the sale and the receipt of the cash related to that sale.
Several elements go into any cash conversion period. This normally begins with the extension of pricing to a customer. Once the pricing is accepted, an order is placed. The process then moves on to the order fulfillment, which may include manufacturing the ordered items, arranging for shipment to the customer, and ultimately the delivery of that order. From there, the invoicing of the order is addressed, with an invoice prepared and forwarded to the customer, with specific payment terms. The final phase of the cash conversion period focuses on the receipt and posting of the payment, with the posting date being used as the closing date for the period.
By assessing the amount of time that it takes to successfully complete each of the events associated with a cash conversion period, a business can sometimes shorten the duration of the period and have access to the cash from the transaction sooner rather than later. For example, if the manufacturing process can be refined to shorten the amount of time needed to produce the items for shipment, this will have an impact on the duration of the cash conversion period. In like manner, if the invoicing process can be streamlined so the client receives the invoice sooner, this helps to promote a quicker issue of payment. Even little things like offering a customer a discount for early payment, or arranging for payment to be made electronically rather than cutting and mailing a check will often help to shorten this period and allow the company to enjoy a more agreeable cash flow.