Cash is King

Is Your Business Trapped In Cash Flow Hell?

The time to expand your business is now

“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

Whether selling a revolutionary product or essential service, the challenges of gaining access to the working capital necessary for production capacity expansion, marketing initiatives, or fluctuating inventory needs affect nearly all businesses.

In fact, more than two-thirds of business owners said they faced challenges growing their businesses over the past year, with more than 12% not understanding how to obtain the working capital necessary to facilitate expansion.1 With increasing frequency, business owners are turning to external funding sources to secure capital to fuel growth as opposed to exploiting the potential capital they have tied up in inventory.

The Cash Can Come From Inside The Business

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

  • gives businesses 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.

The crucial truth that most business owners remain unaware of is that they already have access to the capital they require, and it doesn’t involve cold-calling relatives or meeting a single loan officer. For most businesses, simply optimizing inventory control, cash flow, and operational processes can give them access to ample capital they can use 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.

The Financial Supply Chain, Explained

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

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 pocket for more equity.

The second area that holds the highest amount of promise is the area of 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. The single biggest opportunity to improve working capital is in the area of inventory reduction.

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

Free Your Cash, And The Rest Will Follow

When it comes to generating more working capital, SMEs continue to take the ‘easy’ route and amass mind-boggling amounts of debt rather than improve their own internal processes. In fact, 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 optimizing how they collect from customers, pay suppliers, and manage inventory,” a finding that echoed survey results from previous years.3 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 optimization 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.

Mismanaged Inventory

As a high-velocity cash generating machine, the last thing you want is inventory sitting around a warehouse collecting dust. A large part of inventory optimization lies in 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 best-selling inventory from vendors and suppliers
  • scrambling to fulfill orders to high-priority customers
  • failing to optimize purchasing conditions

All of 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, they have comprehensive visibility into the entire supply chain, with advance 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 optimization applies a number of advanced forecasting methodologies to automatically forecast demand for countless items.

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 absolutely 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 ordering, whenever possible, it’s recommended companies automate this process via software so that automated daily order recommendations are provided when stock dips below a certain threshold or when your forecasting identifies spikes in demand.

4) Shorten your order to deliver period: Reducing lead time and optimizing logistics should be priority number one for companies looking to shorten Days of Working Capital.

There are three distinct touch-points that 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 the time 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.)

5) Shorten time to market of new products: From the moment resources are committed to a new product, you’re burning cash until you can capitalize on sales; therefore, it’s imperative that businesses make every effort to shorten the time it takes to get new products to market. Implementing or improving project management, improving oversight of manufacturing changes, and improving design team collaboration can help put cash in your hands quicker.

Become Your Own Personal ATM

Just how drastic an impact can small shifts in inventory optimization have on working capital?

In this example, we’re looking at a company with:

  • $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 B hasn’t invested in inventory management. Their sales agents are exaggerating forecasts to ensure there are products to sell. Production increases their production rates to meet the additional (nonexistent) sales demand. Their service department is too busy with customers to enter billable time, so invoices are created 2 weeks late. 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 be able to meet the increased sales demand. And on, and on and on.

‘Company A’ shortens the sales cycle by 10 days, extends their days to settle AP by 10 days (to 40 days total, well within the realm of acceptability), and drops Days of Sales inventory from 110 days to 100 days by implementing software that gives them increased inventory optimization capabilities. 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.

With an inventory optimization tool in play, improved forecasting and demand, increased stock turnover, and sustained sales due to improved inventory management, Company A decides they have the ability to cut another 10 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 is shortened 20 days annually, from 190 to 170. Remember that $1 trillion statistic 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.

So How Can You Become Company A? Leverage a Solution That Pays For Itself

When it comes to the question of 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 for most businesses, cash flow is limited. 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. Examining the way 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, organizations are able to invest in multiple projects in tandem, boosting the profitability of the company, 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.

By rethinking how you invest in your business, and avoiding the common trap of opting for the fastest ROI, businesses can dramatically improve their overall operations. 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 Metrics that Matter

When we talk about working capital, we’re speaking about the liquidity available to be used in day-to-day operations. For most businesses, this will be assets (receivables + inventory), 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 optimization?

  • 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 beginning A/R, $1m in beginning inventory, and another $1m in beginning payables, your working capital is $3m.

DSO (or Days Sales Outstanding) refers to the amount of time, on average, it takes a company to collect revenue after the completion of a sale.

DSO = Average Accounts Receivable / Total Sales * 365 For a company with $10m in annual sales and an average AR balance of $2m, DSO is calculated at 73.

DPO (or Days Payables Outstanding) is the duration it takes for a company to settle contracts with suppliers and vendors.

DPO = Average Accounts Payable / Total Annual Purchases * 365 If your annual purchases total $5m, with an average A/P balance of $2m, your

DPO is 146 days.

DSI (or Days Sales of Inventory) is the length of time it will take a company to sell all of its inventory.

DSI = Average Inventory / Annual Cost of Sales * 365

Inventory Turns = Annual Cost of Sales / Average Inventory For a company with an annual cost of sales of $8m and average inventory of $1.5m, it will take 68 days to sell all on-hand stock, necessitating 5 inventory turns in a calendar year.

DWC (or Days of Working Capital) measures how many days it will take for a company to convert its working capital into revenue. The faster a company does this, the better.

DWC = Working Capital/Sales * 365 If payables exceed the sum of receivables and inventory, DWC is negative.

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. 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, just look at your cellphone bill.) Rounding out 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 Hell

The numerous financial and organizational benefits of inventory optimization software can no longer be ignored by companies wanting to reclaim their piece of that $1 trillion pie. The single most important thing an organization can do is to carefully consider the significant way inventory optimization can transform their business. From improving cash flow to reducing dead stock, an inventory optimization solution can make the difference 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 optimization by utilizing 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 to give up the idea of increasing your debt.

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

Published by Slimstock, market leader in forecasting, demand planning, and inventory optimization

Since 1993, Slimstock has been synonymous with better demand forecasting, effective inventory optimization, clearer inventory analysis and continuous improvement of inventory reliability. Our customer base consists of over 650 companies worldwide, across a diverse range of industries, covering large, medium and small enterprises.
www.slimstock.com

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