When Offering a Discount Makes Sense

Continuing our cash velocity discussion started on March 16, 2007

Last time (on Friday) we talked about offering a discount to our customers if they paid on delivery.

What kind of discount could you offer to get cash back into your system faster so that you could make more money? Before you answer that question, also consider that 1) you need to be able to sell the additional products so that you can benefit from the faster cycle. If you offer a discount, get the cash back quickly, but don’t have another order, then this strategy is not a good idea for you. 2) If you have other sources for cash, like a line of credit, you may be better off to use that than to use deep discounting. You’ll want to compare the Return on Investment of each. 3) However, if your cash is close to becoming a constraint, and you have no borrowing options, this idea could keep you in business.

A 20% discount for 42 days is an interest rate of 174%. But the cost of money is less important than the availability. Obviously you would not do this if cheaper money was available.

When we have used this type of offer to recover from a cash constraint, we let customers know that it was an offer we were testing to determine customer interest and that it may not be a long-term offering. This will give you the option of discontinuing the offer once you have another source of cash to grow your business.

.... to be continued ...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Increasing Cash Velocity Can Increase Throughput

Continuing our cash velocity discussion started on March 16, 2007

Now let’s look at the impact on what we discussed yesterday had on our throughput.

Let’s say we immediately visit a customer whose complete order was shipped and had just been received by that customer. We make, and they accept, our 20% Discount Mafia Offer and we collect $320 in cash. We pay the sales commission of $40 so we have $280 left. With the $280 we can buy 2 sets of raw materials ($100 each) to produce 2 more products and still have $80 in cash.

We then sell those 2 products with our discount offer collecting $640 ($320 x 2). We pay sales commission of $80 but had $80 in cash from the first offer, so we now have $640 in cash. We buy 6 sets of raw materials and have $40 in cash left. We sell all 6 products with our discount offer collecting $320 x 6 = $1,920. We pay $240 in sales commission leaving $1,920 - $240 + $40 = $1,720 in cash. Let’s go one more time, a 4th cycle. We take the $1,720 in cash and buy 17 sets of raw materials, leaving $20. If we sell all 17 products with our discount offer we collect $320 x 17 = $5,440. We pay sales commission of $680 leaving $4,760, plus the $20 left from the previous cycle, we now have $4,780 in cash.

So, in 53 days you can sell 1 product and generate $260 or you can make a “discount” offer which enables you to sell 17+6+2+1 = 26 products and generate $2,520 in throughput in 52 days.

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

The Role of Payment Terms in Cash Velocity

Continuing our cash velocity discussion started on March 16, 2007

The Role of Payment Terms in Cash Velocity

To reduce the time it takes to collect payment from our customers we offer a 1%/10 option, but none of our customers use this option and many of them pay late which is why we have an average of 42 days. So we remain at 55 days.

Thus far we have gone from receiving a net of $300 every 134 days to receiving that same $300 every 55 days. If we were to pay out a 10% sales commission (on selling price) once the customer pays, the net receipt would be $260 every 55 days (assuming continuous sales). More than double the velocity.

Our cash velocity has gone from 1.94 ($260/134 days) to 4.73 ($260/55 days)!

This increase in cash velocity can help you to grow your business. The difference in velocity is 4.73 – 1.94 = 2.79. This means we are getting our cash back more than two times faster than before. We can use this cash to fund additional raw materials and grow our sales and profits.

However, if you reduce your cash-to-cash cycle time but do not have the opportunity to increase your sales, what have you gained? The only bottom-line impact you would have is the reduction of carrying cost and the interest you would now be earning on the cash you are accumulating.

In addition, if you have a cash reserve, you are now in a position to take the discount your vendors are offering. If terms are 2% discount if paid within 10 days or full payment in 30 days, what return would you earn? A 2% return on 20 days is equivalent to 36.5% return over a year. That is a good return, but taking the discount depends on what else you could do with the extra 20 days of money. If your company is growing, and you can use the cash to grow, then you may be able to produce and sell another product in that time. The answer then, depends on your cash position and your goals.

Here's to maximizing YOUR profits!
"Dr Lisa" Lang

(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.