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Improving Cashflow in Manufacturing and Distribution Operations
- Part 1.
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 late last year the economy has been slowing down and many
equipment manufacturers and truck equipment dealers 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.
1. 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:·
- 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.
- 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.
- 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.
2. 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:
- Implement Master Production Scheduling disciplines. This process
performs the following functions:
a. 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.
b. Coordinate the delivery schedules of long lead-time or
expensive components such as chassis, mounted equipment,
and chassis bodies. Their simultaneous delivery can be coordinated
to insure they are assembled immediately after arrival.
c. This master scheduling discipline is the most effective
way to manage total inventories and can be established quickly
within an organization. Within only a few months of implementing
master scheduling disciplines we have seen inventory reductions
of up to 25% of total inventory dollars.
- Implement a formal inventory planning system such as MRP or
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.
- The implementation of Just-in-Time inventory management philosophies
on the production floor will simplify an MRP 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
1. 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:
- Insure billings are sent out in a timely fashion with each
order.
- 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.
- 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.
- If a problem has been found, whether in product or invoicing,
fix it quickly and follow up again.
- Evaluate policies for discounts for early payment and compare
the cost of these incentives against the cost of borrowing this
same money.
- Provide bonuses and other incentives to managers that can
positively affect the A/R process.
2. 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:
- Approach suppliers and negotiate for extended A/P terms. Even
extended terms of 10 to 15 days can be significant if this is
done with a large group of suppliers.
- When negotiating for pricing concessions with suppliers a
business should approach extended terms as a desired negotiating
objective.
- 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.
- 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.
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 two
of this article series, we will present additional cash management
techniques that will help improve cashflow for a business.
Click here for Part 2
