One of the basic gray areas we experience in distribution is the concept of cash flow. What is cash flow? The term is tossed around but rarely used precisely or discussed in a practical manner.
In layman’s terms, cash flow is basically the cash received (coming into the business) over a specific time period less the cash going out of the business in the form of payments. You have a positive cash flow when the cash received exceeds the cash paid out - a simple concept. However, managing and controlling cash can become complex. If the cash being paid out exceeds the cash being received in the business, you are in a negative cash flow position. This is critical because, if it persists, your company may be unable to pay its bills and continue operating. It is possible to find yourself in this position even if your profit and loss (P&L) statement says you are profitable.
Cash To Cash Cycle
This cycle is extremely important. This measure illustrates how quickly a company can convert its products into cash through sales. The shorter the cycle, the more working capital a business generates, and the less it has to borrow. The cash to cash cycle is a continuous measure that is defined by adding the number of days of inventory supply to the number of days of receivables outstanding and then subtracting the number of days of payables outstanding. The result is the number of days of working capital the company has tied up in managing the supply chain.
The Formula
Inventory Days of Supply(Inventory $) / (Annualized COGS $ / 365) = Inventory Days of Supply
Days Sales Outstanding
(Receivables $) / (Annualized Revenue $ / 365) = Days Sales Outstanding
Days Payables Outstanding
(Payables $) / (Annualized Material Costs $ / 365) = Days Payables Outstanding
Cash Flow Culture
Create a cash flow culture within your organization. Ignorance of cash flow dynamics can be as deadly to your company as fraud, fire or the competition. If key managers really understand the concepts of cash flow and integrate that knowledge into their management style, then there is no circumstance or problem that can’t be handled in a much more effective and efficient manner. A culture shift is required and it may start with simple basic cash flow analysis training.
Once the culture shift has begun, the next step is to start setting goals that directly impact cash flow. Set goals such as:
Goals should be specific, realistic, measurable and assigned to a single “owner” who will be accountable for their achievement. Attaching incentives or performance measurements to these goals can be effective.
Lastly, it should be clearly understood and reinforced that, as the “heart of cash flow,” revenue is the most dominant contributing factor. Revenue can be theoretically increased without limit, but margin management, inventory, expense control and receivables and payables management have a ceiling of effectiveness. Clearly, increasing the revenue stream coming into the company is the most effective way to improve cash flow. However, revenue growth alone, without consistent knowledgeable management of all the other components, can result in a negative impact on cash flow.
