If you’re like most business owners I’ve worked with over my 20 year career you’re asking “Where is my cash?” The first place most business owners run to is an accounts receivable report and asks who owes us money? Thinking, if everyone just paid us what they owed us we would be fine. Although accounts receivable is a great place to start it’s only one of four places you should be looking.
The cash cycle of a business is embedded in all aspects of the business. We like to explain cash to owners as a cycle, the cash conversion cycle. The cycle encompasses the moment a dollar is spent till the moment you get the dollar back. If you sit back and think about the cycle your whole business is between the two dollars. Made simple we can break the cycle down into four steps: sales, manufacturing and/or procurement, product or service delivery, and billing and/or collection process.
The CEO should be trying to improve the time cash is spent in the cycle. The faster cash moves through the company the better return the company receives on each dollar. If it takes a company four months from the time it spends a dollar to get the dollar back then the company can turn a dollar three times in a year. If the company can speed the process up to three months it can turn a dollar four times year. The math is basic and if you’re reading this white paper you know every time you turn a dollar there is profit in the dollar. Changing a turn of three times a year to four times a year is a 33 percent increase in cash flow and maybe the same increase in profit. Let’s look at each cycle and see how cash flow can be improved.
Most CEOs are great salespeople. They’ve been selling their business for years; however, their most common challenge is having real information to speed up the sales process. The CEOs know their sales process and they know how long it takes to sell their product or service but no one else in the company does. The company lacks REAL data measuring each step of their process. So how can you speed up the sales cycle without real data? GET THE DATA.
The sales team should start measuring several points in the sales process starting from the time a lead comes in until a sales takes place. It is good to count the number of leads as they pass through the cycle and how much time it takes to pass through the cycle. After collecting several data points all the way through the process you can start to make some changes but keep monitoring the data! The longer the data is collected the more revealing it becomes.
Onto step two, if your company is manufacturing goods or purchase materials (if you’re selling services this area may not apply to you) you already know you can speed up the cash cycle in the manufacturing and purchasing areas. In a manufacturing company this cycle usually provides the greatest opportunities for cash savings. Again the challenge most of the teams I work with is data. Is data readily available to help make decisions on how to shorten the cash cycle? Generally, yes but it is not in the form the team needs to see to shorten the cycle.
The CEO and executive team goes over the data the accounting department gathers to see how it can be used to shorten the cash cycle in making the products or providing services. I have seen executive teams invite accountants into a meeting and in one hour the accountants can pull several data points together for operations they never knew could be summarized. Once the data is obtained have your executive team review it then reconvene the meeting at a later time to go over the suggestions for shortening cash cycle times. It’s not uncommon for 20 or more recommendations to come out of a team of 6 to 8 members. The amazing part is it can happen in 20 minutes! The hard part is looking at the data and deciding which ideas to implement first. Generally you’d want to begin with the ones that have the greatest impact in the shortest amount of time.
If your accounting team doesn’t have the data to help you don’t worry about it right now because your executive team already has some very educated guesses on how to improve cycle times. Try a brainstorming session for an hour or two and see what you can download when people put their thoughts together. Don’t let other things creep into the session keep it focused on reducing cycle times. Many times executive teams never take the time to ask themselves how to shorten the times. Many great ideas can come from this type of session if there are no stupid ideas.
There are a few common ideas that seem to pop up over and over again when these brainstorming sessions occur. The biggest one has to do with having the right people in the company. Many times jobs are not cross trained and when we have people who are sick there is no one to step in. Let’s say we are starting a manufacturing process that takes seven steps and seven days to complete, keeping our example simple. If step three is on the third day and I only have four people trained to do step three and no one is crossed trained, if one person is sick I’ve lost ¼ of my capacity. That means ¼ less product is moving from step three to step four which lengthens my cash cycle. Multiplying the cash effect if all my step four people are at work (there are 20 people who do step four) I now have five people with little or nothing to do. You’ll never see these five people not working because the other 15 who do step four will do less so the five with no work will seem busy. This is ONE example of the many suggestions that come from brainstorming sessions on cash cycles in the manufacturing and procurement areas of a business.
Once we have the product ready to deliver the key is to get it out of your warehouse quickly. Every day the product sits is another day your cash is tied up in the cycle. Again having accurate data available to help make informed decisions is crucial when analyzing where the company is falling short on delivery. There are usually communication issues between manufacturing and shipping where manufacturing does not notify shipping when a run is complete and it sits on the warehouse floor for four days before shipping knows it is there. Seems ridiculous, not really! Communication can be linked to many problems inside a company. For example, incomplete orders being shipped because no one communicates correctly with the customer. The lack of communication with the customer delays payment and no one knows about the incomplete order until the account is being collected by the accounts receivable department many days later. Incomplete orders with little or no communication to customers is a cash hog, it can lengthen the cash cycle by two times for some companies and usually involves something small not being shipped.
In the delivery process paperwork can also slow down the cash cycle. I suggest every team check the relevance and lack of forms being used to speed the cycle. The businesses we’ve worked with have had too many forms or not enough. If there are too many forms most likely there are redundancies in the information on the forms. If a product cannot move from one area of the warehouse to the other without the proper forms and the forms are time consuming because of redundant data there could be a great opportunity to speed up the cycle. If there are little or no forms for moving product then there is a good chance you’re shipping product to the wrong customers or shorting orders.
Inventory can slow your deliver cycle down too. Have you ever seen a retail clerk scan an item and it doesn’t come up in the register? Let’s say it is a pack of gum to make it simple. You are buying two packs of gum: one spearmint and one cinnamon. The cinnamon pack will not scan so the clerk just scans the spearmint again to make it easy. Your inventory is now wrong. You’ll pick this up when you do an inventory but if you do an inventory of product for sale once a year that scan could cost you dollars. In the mean time I have a customer come in and they want to buy a box of cinnamon gum and I don’t have any. My company lost. What did I lose if the product cost $2,000 and takes a month to manufacture? You know the answer but the larger question is what does that cost my cycle time?
Now onto the fourth step in the cycle, the step every CEO runs to first, account receivable. The product ships the company sends an invoice and the customer sends a check, right? If you’re a CEO or CFO you are laughing right now. All CEOs and CFOs know it’s usually not that easy to get paid but it should be. Take on sales the company shouldn’t be making and this simple process become complex. One of our previous customers had an average order size of approximately $200,000 to $600,000 per custom order their overhead became so large he had to have the customers, so he said. He gave his customers competitive pricing and accepted every opportunity no matter how stable the customer. He took a 25% deposit and thought if the customer could pay the 25% then they do not need to complete a credit application. At the time of delivery he would take another 40% of the total and give terms on the remaining 35% balance. On a $500,000 order this is $175,000. With the riskier customers (about 20% of his customers) it could take him 150 days to collect his money, if he collected at all. Over a year period he wrote off about 75% of the accounts going past 90 days. He wrote off over $1 million in one year in a $22 million company. His gross profit margin was 20% and he was writing off ¼ of his gross profit (5%) and he could not understand why he was having cash flow problems.
Putting the example above in a cash conversion cycle he spends a dollar, and the time it takes for him to get the dollar back is NEVER. The dollar he was supposed to get back was his profit. The executive team knew of the problem but the CEO wanted to feed his ego to keep his sales over $20 million but getting rid of these sales saved this company. This example is a lot more common than one might think. There are CEOs reading this now saying all my customers are great but because they don’t look at the facts their cash flow is in the toilet.
There are many other ways you can shorten the cash cycle in billing and accounts receivable. Operations and accounting know how to speed the cycle up but they’ve never been asked to focus on the question “How do we speed up the billing process?” Ask them and open your mind to all the ideas presented. There are many opportunities to speed up the cycle in the way is collected too. The company should have clear written procedures on following up on outstanding balances owed. If the policies are already written, is someone making sure they’re being followed? Remember the squeaky wheel gets the grease.
Keep in mind the cash cycle is four steps: sales, manufacturing and/or procurement, product or service delivery, and billing and/or collection process. The time it takes one dollar to go into the cycle and come back out is the cash conversion cycle. Improving the cycle is something every business should constantly be doing because as an improvement is made in one step the improvements made in another step are being undone. The people who made the improvements don’t ruin the change on purpose but human nature that gets in the way and breakdowns start to occur.
Lasting cash cycle improvements only come when there is a team approach. A team approach comes from allowing all ideas to come to the table for debate. Once the debates have taken place the team commits to the course of action and holds people accountable to the change. If you get the commitment and accountability you will have results. Once there are results the team should be constantly evaluating itself.