For companies running small manufacturing operations, working capital is an ongoing source of pain. Long before you see revenue, you’re paying for raw materials, labor, overhead, and operating expenses. And the problem only gets bigger as your enterprise scales up; bigger customers inevitably demand longer payment terms that can reach 90 days or even more. 

There’s a name for this pain: the cash conversion cycle. And for most small manufacturers, it’s been steadily growing worse for some time.

In this article, we’ll take a closer look at the issue and provide three proven ways manufacturers can mitigate its effects on financial resilience and business growth.

Calculating the cash gap

The cash conversion cycle captures the length of time between cash going out of the company (as expenses) and cash coming in (as payment). The longer the cycle takes, the bigger the cash gap your company needs to cover through financing or cash reserves. 

More specifically, the cycle is calculated with a formula: Days Inventory Outstanding plus Days Sales Outstanding minus Days Payable Outstanding equals the cash conversion cycle (DIO + DSO − DPO = CCC). A CCC of 70 or 80 days, for example, means that for every manufacturing production cycle, your cash is tied up for more than two months. By calculating your CCC, you can pinpoint the level of stress the cash gap places on your company’s finances. 

The cycle slows to a crawl

According to research from HighRadius, the average cash conversion cycle in manufacturing jumped from 62 to 70 days between 2022 and 2023. During the same period, accounts payable balances in the sector increased by nearly 42%, meaning manufacturers were carrying greater supplier obligations even as cash was taking longer to come in. At the same time DSO remained stubbornly high at 56 days. For a small manufacturer operating on thin margins, that’s a long time to wait.

Late payments are a big part of the problem. Data from Taulia found that only 44% of invoices are paid on time, with significant delays of more than 45 days on the rise. Those delays can crush smaller operators; QuickBooks research found that elevated late payments made small businesses are 1.4x more likely to have cash flow problems, 1.7x more likely to use high-interest credit cards, and 1.3x more likely to struggle with hiring.

How to close the gap

For small operators without robust treasury functions, credit lines, and diversified receivables, long payment cycles and unplanned delays can be devastating. But the good news is that if your cash conversion cycle is long, there are things you can do to shorten it.

Tighten up your AR processes

The most controllable lever on your DSO is how and when you invoice. A few tweaks to your invoicing process can shave valuable days off this key metric. Start by auditing the payment behavior of your largest customers against the terms of payment specified in the contract. Most owners find that the reality doesn’t match the expectation, and that by simply holding customers to the stated payment terms can have a sizable impact on DSO.

• Send invoices the day goods ship rather than at month’s end.
• Consider offering a modest early payment discount, such as 2/10 (2% for payment within 10 days).
• Don’t ignore late payment. Send a prompt, polite follow-up at five days past due.

Read this article for more tips on tightening up the accounts receivable function.

Be strategic on the payable side

Supplier relationships are a working capital lever that most manufacturers underuse. This is another area worth auditing to identify areas where you have leverage based on the volume of business you do with a supplier or the depth of the relationship you have with them. If there are any opportunities to extend payment terms, take advantage of them. Moving from net 15 to net 30 with even two or three key suppliers can measurably improve your DPO.

In addition, make sure you pay early only when there’s a meaningful discount on offer. Otherwise, delay payment until the due date. Once you’ve tightened up your AR, extending payment terms where possible and taking full advantage of the terms already in place will help you close the cash gap from the other direction.

Have a bridge plan in reserve

Most manufacturers wait until cash is tight to think about financing options, but by then, the choices are fewer and more expensive.

If you know you can be disciplined about using it, establishing a line of credit (LOC) before you actually need it is a wise idea. For companies that have difficulty qualifying for this type of financing, an invoice factoring facility offers a similar benefit. Like a LOC, factoring can be flexible, allowing the company to ramp up access to working capital only when needed. But because factors look at your customers’ creditworthiness rather than your balance sheet, even companies with poor or nonexistent credit can qualify. 

Case study: Tool and die manufacturing

A tool and die manufacturer located in South Carolina had successfully transitioned from a traditional shop to a high-tech company specializing in computer-automated machining. 

The company’s unique technical expertise began attracting large, multinational customers, which drastically altered their CCC. After shifting from 30-day to 60-day payment cycles and suspending deposit requirements, the manufacturer came close to missing payroll. 

Even with no unleveraged assets and a low business credit score, the company qualified for a $500,000 factoring facility, which gave them the ready cash they needed to meet their obligations and fund continued growth. Read the full story here. 

Get ahead of the cash crunch

The fundamentals haven’t changed: manufacturers need to spend money to make money. But the more you can shorten the time between spending and making, the more you’ll make and the faster you’ll grow. By bringing more rigor to your AR and AP processes, and by ensuring you have access to working capital when you need it, you can build a more resilient operation. 

If you’re in the manufacturing sector and you’d like to learn more about how invoice factoring can help you stabilize and grow, talk to one of our regional experts.