Creating a Cash-Lean Business

The New Business Reality

For the first time in decades, instead of experiencing continuous growth, this last several-year period has been one where many businesses have seen revenue reductions of 20% to 75%. Some are still in this slowdown with no bottom in sight while many others have at least hit bottom. The housing industry is now in its third down year and I have seen instances where some housing-related businesses that are still afloat are surviving on sales that are at a third or less than their revenues were three years ago. Few business leaders were able to anticipate this rapid downtrend and implement the changes necessary to proactively ‘right size’ their business operations in anticipation of these new business realities.

There are two major fallouts of this current economy and the first is that it will be a painful financial and cultural process to get the business operations and assets scaled to the right level to be a cash generating business and this process is covered in the next section. The second issue is that that the financial metrics and margin measurements of the new business will be substantially different than the old one. Higher levels of revenues covered a variety of business performance and costing issues, and with the top line now much lower, the hidden problems will now surface and require management actions to both understand and correct. The second section below covers this challenge.

The Pain of Downsizing in This New Reality

Even if the business leaders were on top of their game, there were tremendous cash consumption problems that were inevitable during the rightsizing of their business. The first is due to inventory growth. The timing dynamics of slowing the supply side of their business would take many months before changes made on purchase orders would actually show up as reduced orders at the receiving dock and in the reductions of cash outlays in payables. In the meantime, the orders for materials and goods that could not be cancelled or pushed out would still come in. With revenues then at lower levels, it would also take much more time to clear out these excess inventories and they would continue to balloon to higher levels while the input and output rates were adjusting, all the while consuming more cash until equilibrium was reestablished.

The second major cash drain would be personnel related. Because of the concerns over major impacts on employees, the personnel reductions were almost always trailing the demand changes. As soon as any slowdown looms, Operations managers will change their focus from squeezing every nickel out of the process to one more of spreading their labor, at the cost of productivity, to keep employees busy while they buy time to see if the pending downsize is a reality requiring layoffs. These productivity losses will build while management decided whether they needed to make these tough changes. In addition, once the layoffs started, this process would also require additional cash for severances as well as unforeseen workman’s compensation cases that would spring up.

Third, now the capacity in the capital equipment and facility assets exceeded the demand and businesses were unable to dramatically reduce these costs over the short term. If they were fortunate enough to sell assets or sublease their facilities, the losses would often not be fully recaptured in the tough economy. In addition, it would be difficult to remove enough fixed costs to reduce fixed costs to the same lower proportions of product cost that they were previously.

Finally, there was an unforeseen consequence of these changes and that was the unexpected loss of margins due to product costing changes or errors. There were many reasons for these problems and they are as follows;

  1. With reduced business operations volumes, product costs going into inventory will have to increase due to the greater fixed overhead costs attributed to the smaller number of products over which the overhead costs can be allocated. Therefore, individual product margins will decrease, perhaps making some now unprofitable.
  2. Revenue losses are typically not proportionate across the breadth of products and the expectations for overall margins will now become unpredictable. This scenario is created when the individual product costs are not as accurate as possible due to inaccurate bills of material or there is too much blending of specific direct and manufacturing overhead costs.
  3. For manufacturing businesses, fixed overhead absorption will be a major problem that may require large adjustments at their year-end financial closing and also until the allocation rate is stabilized with the new revenue/production volumes.

The results of the issues in the last section will make it more difficult to forecast gross margins on the lower revenue levels, making it more complicated to create a meaningful business plan during this transitional phase of the business.

Creating a New Future for the Business

Assuming a business is able to weather all of the downsizing changes required, they are now faced with a variety of new challenges. If the downsizing of the business was dramatic enough, it may even require the redefinition of their entire business as well as the customers and markets they serve. In addition, they need to spend considerable effort creating and maintaining excellent materials management and product costing disciplines. Once these disciplines are in place, they will support improved decision making on product offerings and sales account management plus they will support dramatic reductions in inventories while simultaneously reducing purchasing and manufacturing costs. Specific to the last recommendations, business leaders must initiate the following types of programs to insure a profitable future:

  1. Create a meaningful product costing approach by using Activity-Based Costing (ABC) processes to insure every product margin is accurate.
  2. Given the ABC product costing data, initiate design and Value Analysis actions that will bring individual product margins into acceptable levels.
  3. Using the ABC costing approach, understand the leverage points of the business and different product lines and how best to capitalize on these to drive revenues and total margins.
  4. Using ABC costing processes, evaluate the costs and benefits of each service that is provided internally as well as to customers, dealers and distributors.
  5. Using Lean/JIT and ERP methodologies create new operations, planning, materials management and strategic purchasing processes to support the new business model with a minimum of inventory and cash requirements.
  6. In support of good ERP disciplines, create a longterm view of the business with a Master Production Schedule, which will provide the visibility to support effective cost reduction in purchasing and simultaneously increase customer service while reducing the inventory levels of the business.
  7. Given all the new costing and operations restructuring information, create a new model of the business, including staff makeup as well as how to optimize and structure the capital and facility assets of the company.

Given both the importance and complexity of this task, we recommend that you engage a partner, such as OMC, that has the experience in leading businesses through new product development, Activity Based Costing, and implementation of an optimized mix of Lean, JIT and ERP materials and production management philosophies that best suit your redefined business.

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Posted in Blog Post, Growing Businesses, Restructuring Businesses and Struggling Businesses

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