Basic Cash Cycle: Manufacturing Companies
Week (typical example)
0
2. 5
3. 5
6. 5 7.0
8. 5
10. 5
Cash In
Cash Out
Job Variable
Periodic Fixed
Periodic Fixed
General Manufacturing Overhead
Mtl. Payment Range
Rec. Range
Activity
Order
Received
Net Mtl
Received
Ship and
Invoice
Ship Invoice
Paid
Net Mtl
Ordered
Mtl Issued
to Production
Production
Complete
Material Invoice
Paid
Material
Dead Time
Total Changeovers Total VA Time Other NVA Time
FIGURE 2 Reducing changeover and other non-value-added time during production can dramatically shorten the cash flow cycle.
amount of raw material required, but also the overhead
costs of processing purchase orders. With many VMI programs, fabricators house inventory but aren’t invoiced for
it until that material is used. This again allows material
payments to move closer to customer payments, shortening the cash-to-cash cycle.
According to the Fabricators & Manufacturers Association’s “Cost of Doing Business” survey, fabricators have
more than 100 days of inventory on hand, most of which
undoubtedly is raw material and work-in-process (WIP).
Strategic sourcing would help reduce this greatly, as
would the second remedy for reducing the cash gap:
practical lean.
Practical Lean
Lean processes reduce the cycle and lead-times as well
as overall costs involved in order fulfillment. This moves
the materials receipt time and payment time closer to
when you get paid, and reduces the costs associated with
waste in producing the order. Identifying and eliminating
waste obviously reduces costs, but they also reduce cycle
times (and, by definition, WIP); waste activities not only
cost money, they also take time.
First, when an account is more than five working days
late, conduct consistent and polite status inquiries. This
keeps your company on the customer’s radar and shows
that collections are a normal process, not an act of desperation. Follow up with the account every other day
and get a commitment.
Also, try accommodating partial payments for customers clearly in a cash crunch. Accompany this with the
first method described previously until you receive the
payment in full. This technique actually can be leveraged
into commitments from the customer for future business.
For very large receivables owed by a particularly difficult customer, consider hiring an outside professional collections firm that can work the case under your
guidelines. The firm gets paid only when you get paid.
Such firms collect under the client company name and
have the expertise to collect with minimum risk to future
business.
To reduce or eliminate the collections issue and improve cash flow, many companies use factors, where your
receivables are sold to an independent company that collects payment. Typically for creditworthy customers, factors will pay you 75 to 80 percent within a day or two of
the invoice, and the remaining, net of fees, when the balance is collected. However, be very careful in selecting factors. Compare rates charged, and check references
thoroughly.
Another tool is a revolving line of credit with a financial institution. Unlike factors, revolvers still require your
company to collect from customers, but a loan reduces
your exposure. Typically, when the financial institution
receives a copy of the invoice, it will lend you a portion of
the expected receipts, usually between 75 and 80 percent.
When you finally collect the entire amount from the customer, you pay back the loan. This facility is very common, but is harder to initiate currently at attractive
interest rates. Many financial firms offer this service, but
some are very expensive and highly restrictive.
11. 5
One lean methodology for build-to-order, high-mix
companies is called practical lean. During periods of low
capacity utilization, lean processes have only a small effect on lead-times but still reduce costs. But as demand
recovers, practical lean helps reduce cycle time and costs.
Lean involves reducing non-value-added time in a
process, such as changeover times. Usually actual value-added time makes up only a small portion of the overall
production cycle. Designing activities and processes based
on lean principles can have a dramatic impact on reducing the production cycle time and a direct impact on cash
flow. It’s a simple concept, really. The faster a product is
produced and shipped (while, of course, meeting or exceeding quality demands), the faster your company gets
back its working capital investment (see Figure 2).
In other words, lean reduces the cash gap. But lean
also helps improve competitiveness in cost and service
(see Figure 3). It’s common for lean practices to remove
four weeks or more from the cash-to-cash cycle. This in
turn provides a huge buffer against uncertainties encountered in something that’s perhaps most difficult for
a business to control: collections.
Production to
Cash Gap
;me
Material Pay
to Cash Gap
Cash Gap Shrink:
Practical Lean & Strategic
Sourcing
Production
to Cash Gap
Collections:
Tricky Business
Collection of receivables during
tough times can be tricky. Many
large customers, especially if
they represent a significant portion of your business, will use
that leverage to the maximum.
Many customers are in a cash
bind themselves.
You should avoid certain actions, unless the situation becomes totally intolerable. First,
avoid threatening to withhold
the product until payment is received. Exhaust all other means
first. Small companies that use
this tactic too early usually are
paid no sooner and often lose the
business. Second, never show financial weakness or poverty.
Most large customers rate vendor
prospects on stability, among
other things. This tactic, too,
threatens ongoing and future
business.
The most effective methods
involve a combination of tactics.
A Structured Process
Finally, companies should maintain a structured, formal
cash management process. This involves a disciplined expenditures authority “signoff” procedure, which is common. Not so common, though, is developing a detailed,
structured cash forecast, usually looking out about 13
weeks, showing future disbursements and receipts and
their trajectories in relation to bookings and sales.
This forecast involves overhead as well as disbursements that are dependent on production backlogs: material requirements, outsource or service requirements,
labor directly related to the production cycle, and so on.
These include “what if” scenarios that could include new
orders, changes in the timing of cash receipts, as well as
changes in cost. What will happen if the shipment is delayed? What if overtime is needed? Perhaps a machine
breaks down and requires major maintenance. A forecast can account for these scenarios and more.
Companies that have consistently superior cash flows
have become masters at managing these processes. They
essentially simplify and structure the “herding cats” nature of disbursements and receipts into highly manageable and managed processes—a smart thing to do these
days, when cash is king.
time
FIGURE 3 Shrinking the cash gap improves cash flow,
which builds a buffer against uncertainties encountered
in the collections process.
Material Pay
to Cash Gap
Richard G. Kallage is founder and a principal of KDC &
Associates Ltd., P.O. Box 3728, Barrington, IL 60011-
3728, 847-525-6109, www.kdcconsultants.com. KDC &
Associates is a consultancy focused on operations improvement, turnaround management and assistance,
and financial options for small and midsized manufacturers, fabricators, and distributors.
