Overview

Cash flow is the movement of money in and out of a business, which is vital for daily operations and growth, distinct from profit that can be tied up in assets. Positive cash flow ensures liquidity to meet obligations and the article argues that optimizing inventory management is the single biggest opportunity for businesses to improve cash flow and working capital, often freeing up more capital than resorting to external debt.

“As levers of financial management go, none bears more weight than working capital. The viability of every business activity rests on daily changes in receivables, inventory, and payables.”

— S.L. Mintz

The time to expand your business is now. Whether you’re selling a revolutionary product or an essential service, accessing the working capital needed for growth is a challenge nearly all businesses face, and at the centre of that challenge is cash flow.

According to recent surveys, more than two-thirds of business owners reported difficulties in scaling their operations. Alarmingly, over 12% admitted they didn’t know how to obtain the working capital required to expand. Instead of tapping into the cash already tied up within their operations, particularly in inventory, many turn to external debt.

 

What is cash flow

Cash flow is the movement of money in and out of a business. It represents the lifeblood of daily operations, fueling everything from payroll and production to marketing and expansion. While profits are important, they’re often tied up in receivables or inventory and can’t be used to pay suppliers, staff, or rent. Positive cash flow ensures that a company has enough liquidity to meet its obligations, invest in growth, and weather unforeseen challenges.

There are two primary types of cash flow:

  • Operating cash flow: Cash generated from core business activities, like selling goods or services.
  • Financing and investing cash flow: Cash related to borrowing, investing, or purchasing assets.

Healthy businesses are those that maintain a strong, consistent operating cash flowm which reflects not just how well a company performs, but how well it manages its finances. Without enough cash coming in at the right time, even a profitable business can face insolvency.

S&OP

Unlock cash flow opportunities hidden inside your business

The importance of cash flow to a healthy business cannot be overstated. More cash on hand provides the following benefits:

  • Gives companies a competitive advantage.
  • Fuels growth stages.
  • Improves shareholder value.
  • Contributes to the viability of a business.

Businesses rarely go bankrupt because of a lack of earnings, but a lack of cash on hand can be the kiss of death.

Most business owners remain unaware of the crucial truth that they already have access to the capital they require. It doesn’t involve cold-calling relatives or meeting a single loan officer. Instead, for most businesses, simply optimising inventory control, cash flow and operational processes can give them access to ample capital to expand without having to make compromises or sacrifices on initiatives that will yield positive ROI.

So how can businesses access this untapped reserve of cash to fuel growth, boost profits, and increase viability? It starts with examining the financial supply chain.

 

How your financial supply chain affects cash flow

The problem with any organisation is that it has an increasing requirement to raise more working capital as it grows. Often, that working capital will come either from shareholders or out of the company’s asset base. Yet, ironically, most companies constrain their ability to grow by limiting their working capital in two primary areas.

Accounts Receivable

The first area is Accounts Receivable, where companies struggle to reconcile how fast they pay with how fast they collect. The delta between Days Sales Outstanding and Days Payables Outstanding usually contains working capital that can be relieved without shareholders digging into their pockets for more equity.

Inventory

If your company makes, manufactures, or distributes goods, the chances of having inventory on your shelves longer than required or turning over more slowly than required than you need are staggeringly high. Thus, the single biggest opportunity to improve working capital is in the area of inventory reduction.

By fine-tuning each area, organisations can significantly boost their cash flow, giving them access to previously untapped resources that can be funnelled back into the business. Sounds easy? With the right tools, processes, and people in place, it can be.

 

How inventory optimisation can improve your cash flow

When generating more working capital, SMEs continue to take the “easy route” and amass mind-boggling amounts of debt rather than improve their internal processes. A 2015 working capital survey from CFO Magazine found that companies continue to take on “alarming amounts” of debt. Corporate debt rose by over 9% in 2014 to nearly $4.6 trillion, with companies leveraging low-interest rates to fund increased investment activities.

According to the same survey, “companies once again made almost no improvement in working capital management, doing little to generate cash internally by optimising how they collect from customers, pay suppliers, and manage inventory,” a finding that echoed survey results from previous years. Companies that saw their debt double since 2007 had their working capital performance worsen dramatically, while companies that decreased their debt over the same period saw significant improvement.

Most eye-opening was the finding that companies in the study could improve cash flow to the tune of $1 trillion simply by matching the performance of top companies in their industry, with inventory optimisation representing the lion’s share of the opportunity.

$1 trillion is a lot of cash to leave on the table while seeking out record-setting levels of debt. So why are SMEs continuing to ignore the clear benefit of inventory optimization

First, let’s look at the culprits responsible for eroding your cash flow.what is cash flow

Common inventory mistakes that drain your cash flow

As a high-velocity cash-generating machine, the last thing you want is inventory sitting around a warehouse collecting dust. Therefore, a large part of inventory optimisation is increasing inventory turn and converting products into cash sooner. So why is your inventory turn failing?

You may be:

  • Selling the wrong inventory at the wrong time.
  • Carrying slow-moving inventory.
  • Carrying seasonal stock early, before peak season arrives.
  • Struggling to gain access to a best-selling list from vendors and suppliers.
  • Scrambling to fulfill orders to high-priority customers.
  • Failing to optimize purchasing conditions.

These issues can result in a dramatic decrease in sales and occupy valuable real estate, preventing you from acquiring more viable products.

So how can SMEs address these issues?

1. Inventory visibility

Market-leading businesses not only track stock on hand meticulously, but they also have comprehensive visibility into the entire supply chain, with advanced knowledge of when goods will arrive.

2. Forecasting

The ability to make proactive purchasing decisions is essential for companies to remain competitive, and it doesn’t require a fortune teller or psychic. Modern inventory optimisation applies several advanced forecasting methodologies to forecast demand for countless items automatically.

3. Timing

When it comes to proactive purchasing, however, there is such a thing as too proactive. Filling warehouses with out-of-season stock that will lie dormant for months can decimate your bottom line. The significance of not ordering the right product at the right time cannot be overstated.

Due to the innate complexities of inventory management and order, whenever possible, it’s recommended companies automate this process via software so that automated daily order recommendations are provided when the stock dips below a certain threshold or when your forecasting identifies spikes in demand.

4. Shorten your order to delivering period

Reducing lead time and optimising logistics should be priority number one for companies looking to shorten Days of Working Capital.

Three distinct touch-points can be addressed:

  • Pre-processing Lead Time represents the time required to release a purchase order (if you buy an item) or create a job (if you manufacture an item) from when you learn of the requirement.
  • Processing Lead Time is the time required to procure or manufacture an item.
  • Post-processing Lead Time is the time to make a purchased item available in inventory from the time you receive it (including quarantine, inspection, etc.)

Shorten time to market new products

From the moment resources are committed to a new product, you’re burning cash until you can capitalise on sales. Therefore, businesses must make every effort to shorten the time it takes to get new products market.

Implementing or improving project management, improving oversight of manufacturing changes, and improving design team collaboration can help quicker put cash in your hands.

 

How inventory optimisation can turn your usiness into an ATM

By making strategic improvements in inventory management, even small changes can have a significant impact on your working capital.

Here’s an example of how it works, consider a company with the following metrics:

  • $25,000,000 in annual sales
  • $20,000,00 in annual cost of sales
  • $3,424,658 in average A/R
  • $1,500,000 in average A/P
  • $6,000,000 in average inventory

Let’s look at two ways this situation can be handled.

 

Company A Company B
They haven’t invested in inventory management. They shorten the sales cycle by 10 days.
Their sales agents are exaggerating forecasts to ensure there are products to sell. They extend their days to settle AP by 10 days (to 40 days total, well within the realm of acceptability).
Production increases their production rates to meet the additional (nonexistent) sales demand. They drop Days of Sales inventory from 110 days to 100 days by implementing software that gives them increased inventory optimisation capabilities.
Their service department is too busy with customers to enter billable time, so invoices are created two weeks late. By making these three small changes, they’ve managed to free up $1,730,386 in working capital and decrease the runway to convert cash to revenue from 190 to 180 days.
Concerned about causing downtime, Purchasing buys additional inventory, burying the old stock in the back of a warehouse.
Receiving becomes overwhelmed and has difficulty reconciling supplier invoices to receipts, yet pays them anyway.
Shipping subcontracts outside carriers based on the expectation that they’ll meet the increased sales demand.
And on, and on and on.

 

With an inventory optimisation tool in play, improved forecasting and demand, increased stock turnover, and sustained sales due to improved inventory management, Company A decides they can cut another ten days from DSI, shortening it from 100 days to 90 (from the original 110). By simply cutting 20 additional days from DSI, working capital improves to over $2.275m, and DWC has shortened 20 days annually, from 190 to 170. Remember that $1 trillion statistics cited earlier? When you scale this equation across the multitude of SMEs in the US, it’s easy to see how it can be achieved.

 

How small changes in inventory management can turn your business into an ATM

When it comes to new systems versus new equipment, business owners frequently evaluate based on perceived ROI. The problem is that projects with solid ROI potential require capital investment, and cash flow is limited for most businesses. And while the initial reaction is to choose the project that will yield the fastest, it’s imperative to consider what will yield the best. In addition, examining how each project will impact your business over the next 5-10 years will lead to a more sound business decision.

Cash flow doesn’t replace traditional ROI, it accelerates it. By implementing solutions and systems that generate additional cash flow, organisations can invest in multiple projects in tandem, boosting the company’s profitability without making compromises.

For example, two projects are presented: a new system and new equipment, each requiring a capital expenditure of $200k. The equipment has an expected ROI of 2 years, while the system has an expected ROI of 4. However, the system is also expected to generate $500k in additional cash flow annually.

Using the table below, it’s easy to deduce that the capital-freeing expenditure is the wisest investment out of the gate, freeing enough capital to invest in the necessary equipment in year 2, and both projects returning positive yields in the years following.

Businesses can dramatically improve their operations by rethinking how they invest in their business and avoiding the common trap of opting for the fastest ROI. Instead, by choosing to invest in a system that helps generate capital, you’re better able to fuel the growth of your entire organization, including concurrent positive ROI projects.

 

The key metrics you need to improve your cash flow

When we talk about working capital, we’re speaking about the liquidity available to be used in day-to-day operations. This will be assets (receivables + inventory) for most businesses, minus liabilities (payables).

$1 trillion is a lot of cash to leave on the table while seeking out record-setting levels of debt. So why are SMEs continuing to ignore the clear benefit of inventory optimisation?

  • Has beginning Accounts Receivable of $3m
  • Has ending Accounts Receivable of $1m
  • Has beginning Accounts Payable of $3m
  • Has ending Accounts Payable of $1m
  • Purchases $5m from vendors annually
  • Has $1m in beginning inventory
  • Has $2m in ending inventory

Working capital = (Accounts Receivable + Inventory) – Accounts Payable

If your business has $3m in the beginning A/R, $1m in beginning inventory, and another $1m in beginning payables, your working capital is $3m.

 

DSO or Days Sales Outstanding DPO or Days Payables Outstanding DSI or Days Sales of Inventory Inventory Turns DWC or Days of Working Capital
Amount of time, on average, it takes a company to collect revenue after the completion of a sale. Duration it takes for a company to settle contracts with suppliers and vendors. Length of time it will take a company to sell all of its inventory. Number of times a company sells and replaces its entire inventory during a specific period, typically one year. Days it will take to convert its working capital into revenue. The faster a company does this, the better. If payables exceed the sum of receivables and inventory, DWC is negative.
DSO = Average Accounts Receivable / Total Sales * 365 DPO = Average Accounts Payable / Total Annual Purchases * 365 DSI = Average Inventory / Annual Cost of Sales * 365 Inventory Turns = Annual Cost of Sales / Average Inventory DWC = Working Capital / Sales * 365
For a company with $10m in annual sales and an average AR balance of $2m, DSO is calculated at 73. If your annual purchases total $5m, with an average A/P balance of $2m, your DPO is 146 days. For a company with an annual cost of sales of $8m and an average inventory of $1.5m, it will take 68 days to sell all on-hand stock, necessitating five inventory turns in a calendar year. If your company has $1m in A/R, $2m in on-hand inventory, $1m outstanding in A/P, $2m in working capital and $10m in annual sales, your DWC is 73.

 

DWC, as well as the other metrics discussed above, will vary depending on industry and sector. For example, wireless communications have an economy-leading DWC of negative 29 days (meaning they convert working capital into revenue nearly 30 full days in advance. If you’ve ever wondered why this is, look at your cellphone bill). The top five industries for DWC are conglomerates, transportation, industrial transportation, and food retailers and wholesalers.

Regardless of your industry, there are simple steps you can start taking today that will shorten your DWC cycle and put more cash in hand immediately.

 

Say goodbye to cash flow problems: take control of your financial future

The numerous financial and organisational benefits of inventory optimisation software can no longer be ignored by companies wanting to reclaim their piece of that $1 trillion pie. The most important thing an organisation can do is carefully consider the significant way inventory optimisation can transform their business. From improving cash flow to reducing deadstock, an inventory optimisation solution can differentiate between increasing debt and fueling business growth.

At Slimstock, we enable our customers to outperform the competition. Our inventory management solutions are designed to perform structural optimisation by utilising readily available data, so you can reap the rewards of healthy cash flow and increased year-over-year revenue. All it takes is a willingness to accept that you can self-fund and give up the idea of increasing your debt.

Cash is king, and escape from cash flow hell is just a call away.

 

New call-to-action

Assortment PlanningS&OP + IBP