Be mindful of the old adage; “Revenue is vanity, Profit is sanity and Cash is king!“.
There are a couple of quick boosts to your Cashflow that will help to give you Working Capital for use in tuning other parts of your business.
By the time you have arrived at this point in our make-over exercise, you have:
- Identified the products you are going to keep.
- Identified the Bottleneck in your production cycle.
Because you have reduced your product range, you are likely to have an Inventory of this now redundant product.
You should now explore methods of selling out of this now redundant Inventory as quickly and as Profitably as possible.
This will give you a once off Cash injection which will:
- Reduce the cost of Inventory on the Balance Sheet.
- Increase the Profit bottom line.
Although this is a once-off exercise, it may be very worthwhile.
It is certainly preferable to having now redundant Inventory becoming less and less valuable as it deteriorates on shelves.
After identifying the Bottlenecks in the production line, and implementing the associated Drum-Buffer-Rope strategy, it is very likely that you can run down the stock pile of Work in Progress.
While this Work in Progress is running down, you will be buying less resources to input into the production cycle.
This will be a once-off further saving that can go straight to the Profit bottom line.
Again, this is only a comparatively temporary measure but will kick your Profit along.
Go to the article: SM5.4 TOC Drum, Buffer, Rope Optimisation Techniques
This article is part of the Skills Module Theory of Constraints
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A few notes of caution when running down Inventory.
If you sell to your normal buyers it might have the following possible impacts:
- You will fill their demand for some time (called “Channel Stuffing”) which means your normal Sales will decline for the time it takes to sell the Inventory.
- You may be discounting this surplus which will depress your Profit during the Sales period.
- You will be moving Inventory off your Balance Sheet which can have the effect of reducing your Profit in the Profit & Loss Report.
Consult an accountant if you have someone (like a bank) closely watching your Profitability.
- You may be selling those customers an older, and possibly inferior, product so make sure this will not reduce your reputation with them.
Alternatively, if the product is not too inferior, this might be an opportunity to sell at a discount to new buyers to give them a taste.
Just make sure you existing buyers understand that it is an inferior product so they don’t think you are discounting behind their back.
For more reading on Inventory management, search for Inventory at the 12Faces website. Following are several useful links:
- Inventory Re-order Management for Profit and Productivity
- I Don’t Know What is Wrong – scroll down to the Inventory articles
- SM2.11 80/20 Inventory Management
- SM4.2 Capturing Waste in the Wild
Traditional accounting gives a somewhat false impression of Profit in that it accounts for Profit once an item is sold; rather than when the cash is received.
Until the cash is received, the Profit has not truly been realised.
The TOC concept of Throughput takes this into account and argues that, realistically, Profits should not be counted until such time as the Cash is received.
If you can speed up the cash collection then your Throughput of your production cycle has a corresponding increase.
For further reading go to the article: Change Your Accounting Mindset with Throughput Accounting (TA)
This means that if your Cash Receivable process is in poor condition, the cash in hand that you might otherwise have will be delayed.
One way to improve your Profitability picture is to improve your Accounts Receivable (AR) process.
Refer to the article: How to Boost Your Accounts Receivable
Very often, this might be by way of offering a Cash incentive for early payment, but this approach will have the effect of reducing Profit;
This is especially true if the person would have paid eventually.
Therefore, better ways of speeding up the Accounts Receivable, other than offering a discount, should be explored..
You could commence with:
- An early focus on removing any waste in the A/R processing system.
- Invoice weekly rather than monthly.
- In the full spirit of Flow, you might even invoice as soon as the client has delivery. They might not pay immediately but you will at least catch their next payment cycle.
The opposite of Accounts Receivable is Accounts Payable; payments to your suppliers.
To keep your Cashflow healthy you want your Cash collection to be faster than your Cash payment to Suppliers.
Otherwise, you are using your Cash to pay for the bridge time between collection and payment.
This Cash can be used to grow your business.
Alternatively, if you do pay promptly, you might be able to negotiate a discount for (e.g.) payment in seven days.
Your Supplier also needs Cashflow, this might be attractive to them.
There can be a huge bankrolling opportunity by maximising “free Cashflow” for you if your business model permits.
What does this mean?
You get the Cash from selling a product before you ship it and before you have to pay the Supplier.
Essentially your Accounts Receivable is zero and you have the use of that Cash until you have to pay it to the Suppliers.
Several of the most successful companies in the world use their customer’s money in this way to fund their growth. It can work with many businesses selling over the internet.
Dell Computers receives your payment for a computer purchase at the time of ordering and you get it (say) a fortnight later. The Suppliers of parts to Dell probably get paid 30 days after invoicing, which might be a monthly cycle. This means Dell has your money for an average of 45 days before paying the Suppliers.
They can use, what is effectively an interest-free bank loan, to fund their growth.
Amazon is famous for using free Cashflow to the maximum and that has helped it grow to one of the biggest companies in the world. Amazon did not make a Profit for many years (free Cashflow will not increase your Profit) but grew very rapidly on the back of your online payments for purchases.