Shortening the time line of money to improve cash flow
March 11, 2004
Editor's Note: This is the third episode in a mountaintop dialog that Gerald has been having with a "wise business guru." They have been talking about cash flow and the time line of money.
I continued watching the beavers as they worked on their good dam. I realized the poetic similarity between water flow and cash flow, but I was not sure that I was comprehending much more than that.
"Oh, little guru, what does my cash flow problem have to do with those critters playing in yonder puddle?" I asked. His beady eyes glinted from the shade of the bristlecone pine.
"Use metaphor to help your brain sponge," was his raspy reply. I was working on feeling insulted when he added, "See yourself at the discharge point of the dam, waiting for a trickle of water to fill your cup. If the dam allows no flow, you thirst."
"Why have a dam at all, then?" I asked.
"The beavers are prudent to store the snow melt for later use in the dry months," he answered. "It also provides them with safety and a bath. There are many good reasons for them to dam the stream."
"Are you saying that my lack of cash flow is a good thing?" I puzzled.
"Far from that, my wondering wonder. I am telling you that your dam management is faulty!"
"Well, there is no need to get rude about it!" I exclaimed.
"Settle your dander," he chided. "Just as the beaver has good reasons for protecting his lodge, you have good reasons for protecting your business. But the beaver is careful not to let the stream stagnate or flood. The beaver's adjustment, planning, and repair demand a constant effort. You think you run a manufacturing company and you do not think that cash flow management is really a part of your job," he accused.
Before I could voice my bluster, he interrupted me with a question. "Tell me, who are the beavers in your organization? To be clear, I am asking you to identify those who are creating cash flow blockages."
To me, busy beavers were a good sort of thing to employ. Now he seemed to imply that beavers were a problem. "I don't have a clue, but I am sure that you will tell me," I ventured.
His dour expression accused me of making him do all of the heavy lifting. "Where is the cash stored in your organization?" he demanded.
"In the bank?" I suggested.
He laughed. "If you had any cash, it might be in the bank. You are allowing yourself to think only about liquid assets. Your business problem is with excessive amounts of illiquidity. Illiquid assets are like ice—possibly good storage, but hard to drink. Liquid assets are like water—instantly useful but runny and tricky to control. Instead of asking you where your cash is 'stored,' I should have asked where it's 'trapped.'"
I thought for a moment about all of the assets listed on our balance sheet. "Well, I have money tied up in machinery and in inventory," I mused.
"Excellent!" he beamed. "How many kinds of inventory do you have?"
"Yikes! That will take a while to recite. We have sheet stock in various alloys, nuts, bolts, captive fasteners ..."
He waved his ears to interrupt me. "You have three kinds of inventory. You just started talking about raw materials. What do you suppose the other kinds of inventory are?" He paused and seemed to become one with "the force."
"How about work-in-process and finished goods?" I asked.
"Yes, yes!" he shouted. "Now try answering the question again. Who are your beavers?" I stared at him, thinking that maybe my brain was sponge after all. Unfortunately, I was not soaking up wisdom; I was just feeling mentally soggy. I gave him a pleading shrug.
"Anyone and everything that increases your inventories is the answer!" he bellowed. "Maybe you could call them 'pack rats' instead of 'beavers.' But I do not want to insult your staff. They are working hard to do the right thing. You just have failed to give them the tools to regulate their behavior properly," he said.
I thought about my purchasing department converting cash into raw material; the production staff converting cash into labor. Eventually the work-in-process became finished goods. The cash did not come back out of the system until the customer paid for the finished goods.
He seemed to read my mind. "The purchasing people have learned that they can get a better price if they buy in larger quantities. Production people tend to feel more secure if there are big piles of work-in-process lying around. Your sales staff is pressured by your customers to have piles of finished goods ready to ship at a moment's notice."
He looked mournful as he said this. Were it not for his apparent grief, I would have continued to think that piles of inventory were just a normal part of doing business.
"I think that inventory is a normal part of doing business," I sputtered. "My manufacturing company will not run without it."
He gazed down the valley at the ponds. "The beavers collect water, but they do not permit stagnation nor do they flood their lodge. Can you say that you have reasonable and efficient management of your three types of inventory?" I started to nod. "Before you answer that, I must assure you that you do not. Otherwise, you would not have a cash flow problem, and your company would be growing and prospering." He beamed as if he had revealed a great truth.
I was feeling a little dizzy. Maybe it was the lack of oxygen at high altitude. Or maybe it was the combination of messages he was giving me about cash flow being the highest priority for my business and about my business management being feeble.
"Most of the time your cash is tied up working for your customer. That is what I call the time line of money," he pointed out.
Suddenly my sponge started to feel brainy. "The time line of money starts when I start spending cash and stops when I collect payment?"
"Correct that is," he replied. "Throughput matters?" His ears dropped in a perfect imitation of the famous Yoda.
Apparently I had stated the obvious. Undeterred, I went on. "Prompt payment is vital?"
He nodded with a tear in his eye. I assumed it was because he was very proud of me as a student.
"Your first priority in turning your company around is to shorten the time line of money. To do that, you first will have to analyze the current status of your illiquid assets, develop and enforce procedures for regulating your inventories, and do business only with your best customers."
As he said this he folded his little self into a meditative pose. A dreamy smile grew as he contemplated the future with all of those actions bearing fruit.
I was both fascinated and alarmed by his suggestion that we should do business only with our best customers. "Let me tell you a thing or two about my customers!" I huffed. "Once upon a time, we allowed a single customer to grow to supply nearly half of our sales. When the semiconductor industry hiccupped, we were sent on a roller coaster ride. As a result of that terrifying experience, I vowed that we would develop a diversified customer base. So now we serve not only a wide range of industries, but also many different-sized clients. That is a good thing!" I insisted.
"Jack of all trades and master of none," he grumbled. He brightened and asked, "Do you have a report that shows how much business you do with each customer?" I quickly nodded my head. "Do you have a report that shows how much profit each customer brings you?" I was not sure that I had seen that one lately. "Do you have a report that shows how much overhead is required to service each customer?" I knew we did not prepare that kind of report.
"We do have a minimum charge," I said defensively. "That keeps our inside sales staff from wasting time on little bitty orders," I explained.
He seemed disappointed. "You have some work to do in analyzing your customer base. I like your idea of having a diverse portfolio of clients, particularly in different industry segments. Frankly, I am less impressed with the diversity in size," he said.
Before I could explain to him that pickings were slim in this slow economy, he fired his printer and handed me a report ranking my customers by sales volume. It seemed that he could hack into any part of my network with his laptop.
"Amazing! Eighty percent of your sales comes from 20 percent of your customers," he announced. "Put another way, 80 percent of your customers represent a service burden.
"The trick is to maintain a balanced portfolio," he said. "You need some blue chips, and some with growth potential. It is vital to get rid of the deadwood!"
"You sound like you are talking about investments instead of customers," I observed.
He nodded happily. I wondered how to go about losing customers in a strategic way.
The saga continues in next month's issue.