Cash is king. It is the lifeblood of every business. Often the one resource that limits a company’s ability to grow profitably is its lack of available cash, whether it is generated internally or through outside financing. However, there are ways to free up cash within an organization and use this cash to fund business growth. This article shows how to restructure a business to use cash more efficiently.

Since 2007 the economy has been slowing down and most manufacturers have experienced decreasing sales backlogs. If they were caught unprepared they have seen increases in inventories, reduced and cancelled sales, and increases in their accounts receivable balances. All of these scenarios can hurt the cash levels of a business. Every business goes through these cycles periodically and often they struggle to quickly readjust their operations to function optimally within these new market parameters.

Every business manager really has a threefold task: earning profit, controlling the company’s financial condition, and preventing “cashouts.” Whether in a growth cycle or a downsizing often the greatest challenge of the three listed is maintaining adequate cash levels to fund the day-to-day operations of the business. There are many factors that can have an impact on cash levels in a business. However, there are ways of structuring a business so that it is quicker to respond to sales orders and market changes while simultaneously decreasing cash needs. In this article, we will discuss many of the options available to companies to facilitate this restructuring.

The Important Element of Time in Cash Management

In the last twenty years of business there have been many new business models introduced. These new concepts, with names such as World Class Manufacturing, Cellular Manufacturing, Lean Manufacturing and Demand Flow are all just adaptations of the Toyota Manufacturing System developed by Toyota Motors in Japan. All of these programs emphasize cellular manufacturing, work team concepts, and pulling inventory “Just-in-Time” through the manufacturing plant in small batches. The common elements of all these concepts are the minimizing of assets and the time consumed in all processes. If the level of assets required or the time they are used is minimized, the costs to own or finance these assets are also minimized. This scenario decreases cash needs in the business and frees this valuable resource for use elsewhere.

Therefore, the reader will see one reoccurring theme in this article and it is about mastering the management of time in order to improve cash management. There are four overall concepts that must be grasped in order to understand the specific recommendations listed in the article. All of the progressive manufacturing concepts listed above cover these themes in some manner and support the recommendations of this article. These themes are:

1. A business should position its vendors to own their supplied inventory and carry the cash outlay as long as possible within the manufacturing or product delivery cycle.
2. With respect to owned inventory a business only needs to have minimum levels of the right components or products, often measured in hours of inventory, and move it through their operations as quickly as possible, minimizing storage steps, space requirements, as well as the management decisions that supervise the process.
3. Once launched into production the products must be processed only once, in a minimum amount of value-added or processing time, a minimum of throughput time, and provided to the customer in an defect-free condition that facilitates the timely conversion of these products into cash.
4. All administrative and overhead functions should be structured and managed to support these concepts.

There are many ways to improve cashflow and for your consideration I have put them into the following general categories: instilling business and operational planning disciplines and processes, improving the financial cash management processes, increasing profitability, and turning assets into cash.  We will cover the recommendations in detail below and provide some guidance in how to capitalize on each one.

Instilling Business and Production Planning Processes.

Improve business planning processes

If there is a consistent failing among small and medium-sized businesses it is a lack of commitment to long range or strategic planning. The old saying “If you don’t know where you are going then any road will take you there,” is very descriptive of the lack of strategic vision of many businesses. It is critical in cash management to define priorities and the tactics to be used in running a business.  Listed below are actions in the planning area that can help:

1. Implement strategic planning disciplines. Strategic planning creates a vision for the future of the company. It insures that the leadership has defined the priorities of the company in the area of markets and customers served and which products will be used to serve these customers. This disciplined roadmap communicates to the entire organization where they are going. It insures that scarce resources, such as cash, are committed to the priority programs, products, and operational areas that will optimize the return for the business.
2. Operational planning disciplines are more prevalent in small businesses today and are commonly known as the budget planning and review process. However, this procedure – which tells how to get to a predetermined destination and the progress to date – can be wasted if the company does not have a rational and defined strategic plan. Good operational planning disciplines will monitor the daily use of cash and insure ratios and balances stay within desired limits.
3. Both of these planning processes are important to the success of a business. One provides a target or destination while the other monitors progress and makes adjustments while on the journey to get there. One without the other will lead to poor financial performance and greater consumption of cash.

This business planning process is an entire study in itself, and if these concepts are foreign to the reader then they should investigate the matter further.

Improve the production and materials planning processes.

This process is critical to the effective use of cash because if too much material or the wrong product mix is scheduled or if not enough capacity is available to complete the orders on time, inventories will balloon and consume cash.  Listed below are planning actions that will help a business substantially in the use of cash:

1. Implement Master Production Scheduling disciplines. This process performs the following functions:
   • Provides planning visibility from six months to a year out in the future and determines capacity and product mix needs. If problems in either area exist the master scheduler initiates actions to rectify the problem long before it impacts the performance of the business.
   • Coordinates the delivery schedules of long lead-time or expensive components. Their simultaneous delivery can be coordinated to insure they are assembled immediately after arrival.
   • This master scheduling discipline is the most effective way to manage total inventories and can be established quickly within an organization. Within only six months of implementing master scheduling disciplines we have seen inventory reductions of up to 33% of total inventory dollars and after one year, a 50% reduction.
2. Implement a formal inventory planning system such as ERP to show net material requirements and provide visibility for purchasing. This process is especially important when there are independent demands for items in inventory such as service parts. This is a long-term journey and business commitment to implement these systems but their absence will eventually impede a company’s planning capabilities and ability to grow.
3. The implementation of Just-in-Time inventory management philosophies on the production floor will simplify an ERP installation and minimize both inventory and planning decisions. However, these systems do require expertise to set up but the impact can be tremendous. In one of our installations of these systems, the inventory needs on a $25M business were reduced from $8.0M to $1.0M while order fill rates were simultaneously increased from 77% to 99%.

The production and materials planning process is the major driver of inventory-related decisions and must be managed well. Pay special attention to planning details when the business is going either through a large business capacity increase or decrease. In both cases, inventory can increase and worker productivity can be negatively affected. Listed below are the reasons for concern in each situation:

Capacity Increase: In a buildup situation, the materials requirements are much greater for suppliers. The delay of even a few components of an order can create a buildup of incoming inventory and work-in-process inventory that cannot be shipped. In addition, there are often manpower capacity problems caused either by personnel availability or training. This shortage of trained labor allows purchased inventory or components to sit longer before being consumed into a shippable product. In order to minimize additional cash requirements, planning personnel must schedule materials and production at a reasonable and achievable rate of increase for the business.

Capacity Decrease: In a capacity downsizing situation, special care must be given to incoming and planned material purchases to insure that they match future demand needs. De-expediting materials effectively will demand much more time than a corresponding increase. A downsizing of labor will also need to be enacted. This decrease can start with the elimination of overtime and allow the workforce to reduce through attrition. The next step would be to reduce weekly hours and finally consider layoffs. If these labor downsizing steps are not enacted in a timely and effective manner, there will be excess labor available and it will create a great drop in productivity. However, during this downsizing action, management efforts must be taken to maintain the morale and productivity of the personnel.

Improving the Financial Cash Management Processes 

Improve Accounts Receivable process.

In this effort, the business is trying to reduce the time it takes from the shipment of an order to receiving payment from the customer. Most efforts dealing with Accounts Receivable normally come from the accounting department but many other departments can have a significant impact. Listed below are many ways to improve the receipt of cash:

1. Insure billings are sent out in a timely fashion with each order.
2. Insure that the correct products are shipped to the customer and that the corresponding billing statements are accurate. Errors can cause costly delays and provide an excuse for late payment.
3. Develop follow-up procedures to contact the customers and insure they have received the right products and the corresponding invoices and that nothing will stand in the way of a timely payment.
4. If a problem has been found, whether in product or invoicing, fix it quickly and follow up again.
5. Evaluate policies for discounts for early payment and compare the cost of these incentives against the cost of borrowing this same money.
6. Provide bonuses and other incentives to managers that can positively affect the A/R process.

Develop means to benefit from the Accounts Payable process.

In this role the business is trying to free up cash by using the supplier’s money for a longer period of time. Listed below are some actions to consider:

1. Approach suppliers and negotiate for extended A/P terms. Extended terms of 10 to 15 days can be significant if this is done with a large group of suppliers.
2. When negotiating for pricing concessions with suppliers a business should approach extended terms as a desired negotiating objective.
3. Insure that invoices are correct, that they match the products shipped, and that the product conforms to quality standards. A business should not pay any invoices that do not meet all three criteria.
4. Evaluate accounting practices. For example, if bills are paid on the first and third Friday of each month then some invoices may need to be paid early in order to be paid on time. Realign payable days in accounting to maximize the use of the supplier’s terms, which should reflect at least issuing payments each week.

Summary

Many businesses are failing to achieve the success they should because of a lack of established business priorities and an action plan. This important process starts with casting a vision for the company with strategic planning. The next step is the creation of an operational action plan. Finally, the last step is the development of the production and materials planning disciplines that manage the day-to-day production operations of the business. Once an overall plan is created, a business can establish the priorities and operating procedures for the management of cash. In Part 2 of this article series, presented in two weeks, we will present additional cash management techniques that will help improve cashflow for a business.