Finance Cheat Sheet: Cash is King!

One Two Years = 67%

Three Five Years = 50%

Six 10 years = 30%

Small Business Administration Business Failures

One thing has not changed.  And that is the simple fact that most companies fail because they run OUT OF CASH!

So how do you beat the odds?  I have three suggestions.

1.     A good read that I’ve blogged about before is the book “The Agenda”, by Michael Hammer.  Hammer makes the point that over time, ALL products and services eventually become ‘commodities’.  The real differentiation that emerges is the customer experience – and that experience is determined by your company culture and business processes.  He hones in on the ‘cost of doing business’ with your company and asks the question, ”Is your company Easy To Do Business With ?”  Do you deliver your products and services smoothly?  Or do you try (unsuccessfully in most cases) to push the cost of doing business out the customer?  Are you creating opportunities to add creative value?  Most Important:  Do you make it easy for customers to pay you?  The best way to make your organization successful is to create a culture of constant improvement that puts a laser focus on making it easy for customers to do business with you – and making it easy PAY YOU!

2.     Instead of working for Cash, put Cash to work for you!  Do you understand where your company generates Cash and where it uses Cash?  A key tool in understanding this dynamic is referred to as the Cash Conversion Cycle (CCC) .  Defined simply, CCC is the amount of time it takes from when you invest a dollar into your company that it is paid back to you!  And to illustrate the calculation, I’ve created a Finance Cheat Sheet – Cash Conversion Cycle.  In this simple example you will see that despite generating a positive net income, this sample company is burning Cash because of a 75 day Cash Cycle.

In this case, the company is investing Cash for 105 days (60 days in Inventory and 45 days in Accounts Receivable) with a positive benefit of borrowing from its vendors on 30 day terms.  Net CCC = 75 days.  Point to make here is that you need to look at all aspects of your business.  Are there ways to reduce your ‘investment’ in operating assets such as Inventory and Accounts Receivable?  Can you push your vendors for longer payment terms?  Some popular business practices that can reduce these investments are:  Demand Forecasting, Just in Time and EOQ Inventory Management, Point of Sale Billing & Collection Acceleration Tools and Competitive Bidding and Strategic Vendor Management.  All other factors being equal, this sample company will have a negative cash position of minus $45K.

CCC’s vary dramatically across industries.  As a fulltime CFO, I worked with a company that sold ERP systems to municipalities.  By changing several business processes, we dramatically reduced our average collection period (DSO = Days Sales Outstanding) from over 200 days to under 60 days generating $12M in cash flow.  However, 60 days was about the best we could do as it took at least that amount of time to get payment approved and processed by a municipality.  In contrast, I’ve recently helped launch a network marketing company that collects all sales to its distributors via credit card.  Needless to say, our DSO is the 1.5 to 3 days it takes to get paid by our credit card processors.  This company has a positive cash conversion cycle that adds $600K to their cash coffers.

  3.     Third point I would make is to ALWAYS have an answer for “When and How Much ?”  As mentioned above, it takes Cash to start, grow and maintain a competitive company.  And if the company is not yet generating positive Cash, you will need a source of funding.  The planning here needs to be both short term and long term.  Two of the tools I use to capture important Cash planning is a rolling 90 Day Cash Flow forecast and an Annual Operating Plan.  You need to set goals for generating Cash or fund raising and attain them.  The MD&A in DELL Computers annual report states their Cash goal.  Maintain sufficient Cash to cover one year’s operating expenses. And always remember, the worst time to get a loan or equity is when you really need it!  So follow the sage advice and “Dig your well before you get thirsty.”

Please add you comments & experiences of ways to accelerate cash conversion and put cash back working for you!  Not visa-versa.

Please click on the subscribe button & leave a comment below.

Robbie Chidester