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.

Cash Constrained Company Example

Continuing our cash velocity discussion started on March 16, 2007

Reducing Float for the Cash Constrained Company

Now let’s consider a case where there is a cash constraint.

When cash is your constraint, going out of business is usually not far behind. Most small businesses go out of business because they have run into cash trouble. A cash constraint situation can occur to profitable businesses simply because they must pay vendors before they receive their payments – their cash-to-cash cycle times are too long.

Let’s continue with the company who has a cash-to-cash cycle time of 55 days. Because their cycle time is a positive number it means that they must pay their vendors for raw materials before they get paid by their customers. But now, our company has a cash constraint and they can not buy any raw materials. What can be done?

We need to collect enough cash to buy raw materials so we can work our way out of this jam. Consider the impact if we offer a 20% discount on any order paid in full on receipt of goods (a temporary Mafia Offer) . The product sells for $400 but our truly variable costs for this product are only $140. That includes the 10% sales commission. For customers that take the discount, the cash cycle time would be 13 days with throughput of $180 ($400 less $140), almost a velocity of 14! Any customers that pay full price and take the 42 days to pay, their cash to cash cycle time remains at 55 days with throughput of $260 (4.73 velocity). Therefore, we have almost a 4:1 cash cycle if customers take the discount. What a difference!

... to be continued ....

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.

Goldratt's Theory of Constraints Demand Pull

Continuing our cash velocity discussion started on March 16, 2007
Side Bar for Wednesdays March 21 post:

To minimize the amount of materials we have on hand, we should examine our purchasing policies. Many times we purchase in large quantities to save money. If we purchase in large quantities, we can often receive a quantity discount, and we also can spread the transportation cost over more items. This savings in raw materials and logistical costs are a mirage, because we have to store what we don’t use and we are at risk for inventory obsolescence. If instead, we replenish our materials based on the Demand Pull / Replenishment systems, then we can minimize what we have on hand while ensuring that we have what we need. In addition, our cash position is stronger. We will have only spent/invested what was necessary.

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

Mafia Offer Podcast

I'm taking a break from our cash velocity discussion today to make you aware of my second podcast. In this podcast Jeff "Ski" Kinsey probes with some interesting questions regarding mafia offers and our Mafia Offer Boot Camp.

The newest podcast is available here: http://tppress.blogspot.com/2007/03/dr-lisa-podcast.html

My first podcast on mafia offers is here: http://www.podcasternews.com/programs/87/better-process-podcast/3574/?A=1 This one has had well over 1000 downloads just since Feb 7, 2007.

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

Here is one of the very interesting questions and the answer:

QUESTION: Confirm for us, please, why a "hands on" boot camp approach is so much more valuable than other techniques.

ANSWER: When most of us are presented with a concept, particularly if it is not one we developed we have this wonderful ability to think of all the reasons why it won’t work. So if someone told you your mafia offer or you read about the process to create one … you would simply do what we all do—come up with all the reasons why it won’t work for you.

During the boot camp YOU and your team build your mafia offer. You know your company, your competitors, and customers best. We combine your knowledge with a solid process to facilitate and guide you to develop the offer that is unrefuseable to your customers but something your competition can’t or won’t do. We usually know we are on track when YOUR team is worried about being able to deliver the offer. This happens because we first develop the offer, assuming we could do anything and setting aside all our current assumptions, reasons why we can’t change and current way of doing things.

We start over, with fresh eyes and a fresh look at your business – and this is something you can’t read about or someone just tell you about.

Goldratt's Theory of Constraints Demand Pull

Reduce Material On-Hand to Reduce Cash-to-Cash Cycle Time

To reduce the number of days we have material on hand, be can implement Goldratt's Theory of Constraints Demand Pull[1] solution. We know from Demand Pull that historically we compensated for not having a good scheduling system and for our customers providing ever moving but always wrong forecasts by holding more raw material than we actually need. And still there would be situations when we had too much of some raw material, but not enough of what we needed. By implementing DBR Scheduling and Demand Pull, there will be an overall reduction in the amount of raw material we need to carry, and a higher probability that we will have what we need, when we need it. We also know that our ability to reduce the amounts of raw materials we carry is directly related to the time it takes us to reliably replenish.

Continuing our example from yesterday:
Our vendors have not implemented DBR Scheduling, so it takes them about 21 days to replenish us. So, for our example, let’s say that the mean time we have raw material on hand goes from 90 days to 30[2] days. Now our cash-to-cash cycle time is down 60 days to 55 days (115 less 90 days plus 30 days).

[1] To learn more about Demand Pull see the interactive program, The Insights by Goldratt
[2] We are allowing 3 days of transportation time and 6 days of buffer in addition to the 21 days to replenish.

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

Drum Buffer Rope / Simplified Drum Buffer Rope

Reduce Process Time to Reduce Cash-to-Cash Cyle Time

To reduce the number of days to make and ship the product from the time the order is received; implement DBR[1] Scheduling which results in a mean reduction of lead-times of 70%[2]. For the example we started yesterday, let’s say the 4 week lead-time would shrink to 9 days. That gives us a new cash-to-cash cycle time of 115 days (134 days less 28 days lead, plus the new 9 days lead).


[1] We actually implement S-DBR, Simplified DBR (also known as DBR II) in most cases. You can learn more about S-DBR in the book Manufacturing at Warp Speed by Eli Schragenheim.
[2] The World of the Theory of Constraints, Mabin and Balderstone

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

Decreasing Cash-to-Cash Cycle Time

The components of your cash-to-cash cycle time depends on your business but generally includes procurement, raw materials inventory, production, finished goods inventory, logistics, and your accounts receivable. To reduce cash-to-cash cycle time, you can reduce all or any one component. Let’s start at the front end of a typical process and work our way to collecting our cash.

Cash-to-cash cycle time starts when you have to pay for your raw materials. This means that we take into account your payment terms. Consider the raw material on hand. If you received an invoice with your shipment, and if it’s due in 30 days from the date shipped, and it spends 4 days in transit, and you normally operate with 90 days of inventory on hand, you then have 64 days that count toward your cash-to-cash cycle time. If you are given the option to take a 2% discount if you pay within 10 days, then that effects both your Throughput and your cash-to-cash cycle time. We’ll come back to that option later. If you have multiple raw materials with different terms, transit times, different prices, and different amounts of inventory you can calculate a weighted average but let’s keep our conversation simple.

Next, we convert the raw material into our product. Let’s say that our manufacturing lead-time is 4 weeks or 28 days. That’s the time from when we take the raw material out of inventory and start to convert it to our end product.

We are in a make to order environment, so when we complete the order we ship the order to our customer. So we have no finished goods inventory. Our terms to our customers are 30 days from our ship date, but our accounts receivable (A/R) is typically 42 days.

In this example our cash-to-cash cycle time is 64 + 28 + 42 = 134 days. Let’s further say that we sell our product for $400 and that our raw materials are $100.

To reduce the cycle time, we can:

• Reduce the number of days to produce and ship the product
• Reduce the number of days the raw material is on-hand
• Reduce the time it takes to collect payment from our customers

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

Increasing Cash Velocity using Theory of Constraints

Cash velocity is a component of the wider topic of cash flow. Both cash flow and cash velocity are like good health. When you have it, you don’t really notice. But for many companies the time between when they have to pay their vendor and when they get paid is large and getting larger. In many industries customers are pushing out payables to improve their cash positions, thereby reducing yours.

To stay clear of cash troubles we need to understand cash velocity and investigate some strategies to increase it. So let’s jump right in!

Cash velocity is the throughput (T) you generate divided by the time it takes to generate the throughput. Throughputis the selling price of your product/service minus what you paid your vendors (your TVCs[1]) to generate and sell your product/service. The time it takes to generate the throughput is the cash-to-cash cycle time. Cash-to-cash cycle time (CtC) is a ratio that serves to highlight the amount of time a company must finance raw material. It is the time between when you spend money[2] necessary to produce your product or service until you get paid from your customers for the finished goods or services.



You can impact cash velocity by:

• Increasing your throughput
• Decreasing your cash-to-cash cycle time

The rate (or velocity) at which you generate throughput is as important, and at times may be more important than the dollar amount of throughput. Generating $100 of throughput in 30 days, a velocity of 3.33, is much different than generating $80 in 10 days for a velocity of 8. The higher the rate or faster the velocity, the better. For that reason, let’s first focus on decreasing cash-to-cash cycle time.

[1] TVCs are those costs that are incurred because you produced and sold one of your products or services. They include things like raw materials, subcontracted services, freight, sales commission. See Goldratt's Throughput Accounting as developed in Theory of Constraints.
[2] When you pay for your TVCs.

tune in on Monday for more ...

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

Definition of Cash Constraint

I'm currently working on a book "Maximizing Cash Flow: The Theory of Constraints Way". Goldratt doesn't cover cash flow and it's not even included under the topic of Throughput Accounting. It is however, one of the most important topics for business owners. 80% of the businesses started with year will be out of business within 3 years and the reason is CASH. Many of these businesses will have even been "profitable" when they were forced to close. This happens because they run into a cash constraint.

Cash is your constraint if and only if[1]:

• You have sufficient orders AND
• You have sufficient capacity to fulfill orders AND
• You have sufficient vendors to supply the raw materials/services needed for the orders AND
• Your vendors are refusing to supply on credit and they will supply only against cash AND
• You do not have enough cash to pay your vendors so that you can fulfill your orders.

When cash is your constraint, going out of business is usually not far behind. Most small businesses go out of business because they have run into cash trouble. A cash constraint situation can occur to profitable businesses simply because they must pay vendors before they receive their payments – their cash-to-cash cycle times are too long.

Send me your #1 question about cash to Question@CashVelocity.info and I will send you the answer to your question along all the other questions/answers that are submitted.

[1] Definition adapted from one provided by Ravi Gilani, a TOC Consultant in India. Ravi helps clients by putting the right measures in place.

Factoring Receivables

Should I factor (sell) my receivables? I could use the cash, but the cost seems too high.

This question is hard to answer without more information, so let’s look at an example:

Let’s say it costs you $40 to make a product you typically sell for $100. If you could get $100 dollars in 60 days from your customer or $80 dollars in 10 days from selling the invoice, which would you prefer?

To compare the 2 options, let’s calculate the amount of Throughput that each option would generate in 60 days. Remember, Throughput* = Sales Price – Truly Variable Costs.

Option 1: We wait to collect the accounts receivable in 60 days. Therefore in 60 days we generate $100-$40 = $60 in Throughput.

Option 2: We sell the invoice and receive $80 in 10 days. Therefore we reduced our cash to cash cycle time and have generated $80-$40= $40 in 10 days. But we still have 50 days to go, so we invest our $40 in more raw materials and sell another product. For that product we also sell the invoice and generate another $40 in Throughput. We now have 40 days to go, so we repeat the process 4 more times. In 60 days we generate $240 in Throughput.

So the answer is “it depends”. If you have a use for the money that will generate additional Throughput, then you’re on your way to maximizing your cash flow and your profitability! If you have plenty of cash or access to low interest cash, then it doesn’t really make sense. Calculate the annual interest rate and you will see what I mean.

Another way to accomplish the same thing is to create a Mafia Offer where you offer deep discounts if your customers pay very quickly. However, if you decide later that you don’t want to offer this option anymore, then you have to explain that to your customers.

*Throughput is defined in Throughput Accounting as originally developed by Eliyahu M Goldratt, developer of Theory of Constraints.

Goldratt Theory of Constraints Articles, News, & Success Stories

I have been collecting Goldratt Theory of Constraints articles since 2004. I post all of them on my website. The articles include TOC implementation success stories, general knowledge articles, and instruction of the use of the various Theory of Constraints tools - Drum Buffer Rope (DBR), Simplified Drum Buffer Rope (S-DBR), Viable Vision, Demand Pull / Replenishment, Critical Chain Project Management, Solutions For Sales, Marketing (Mafia Offer), Throughput Accounting, Strategy, Cash Flow, Cash Velocity, and Cash to Cash Cycle Time.

You will also find a number of book reviews. There are several reviews of The Goal by Eliyahu Goldratt.

In addition, there are several articles on Theory of Constraints with Lean and Six Sigma.

At the end of 2006 I also created a 140 page document containing all the articles from 2006. Look for the document titled: 2006 COMPLETE LIST 140 pages

You will also find a link to a bank of Theory of Constraints implementation data. While there have been 1000s of implementations, the bank has about 80 success stories.

Here is the link to the articles: http://www.scienceofbusiness.com/Default.aspx?tabid=122
You will have to register (which is free) to be able to view and download them.

Here is the link to the database of 80 success stories: https://toc-goldratt.com/index.php?cont=2&ext=9&partner=DR-LISA-partner

Why should I buy from you?

If I am one of your best prospects, what would you say to convince me to do business with you? If you didn't write down your answers yesterday, do it now BEFORE you read on.

Here is a list of the typical answers:

§ We provide great customer service
§ Our quality is outstanding
§ We innovate and/or help our customers to innovate
§ We have great employees
§ We deliver results
§ We have a very knowledgeable staff
§ We are responsive to our customers’ needs
§ We have a great reputation
§ Our customers trust us

Don’t your competitors say the exact same thing? All good companies have these qualities or they wouldn’t be in business for long. I call this the "blah, blah, blah" answer because that’s what it sounds like to your customers and prospects.

A mafia offer is NOT a list of strengths, a cliché, subjective, or offered by the competition. In addition, it is sold differently. When you have a mafia offer, you are making a business proposal. Everything changes.

"Create a market offer so good, that your customers can’t refuse it and your competition can't or won't offer the same – that’s a “mafia offer”!” -- “Dr. Lisa” Lang

Competitive Advantage Quick Test

It turns out that mafia offers are possible for the majority of companies. The reason that most companies don’t know that they have one or know what it is, is because they just don’t know how to develop them. If you read Dr Goldratt’s book It’s Not Luck, you read about how we use cause and effect logic (the TOC Thinking Processes) about your customers, your industry, and about your company to create the offer. You also know that it’s not easy to do.

During my years in the consulting business I have asked many owners one question – if I am one of your best prospects, what would you say to convince me to do business with you? What are your competitive advantages or your edge over the competition?

Write down your answers and tune in tomorrow.

Mafia Offer Development Guidelines

To develop a mafia offer you need to consider 3 things.

–Your capabilities (or what they could be) compared to the competition.
–How your industries supplies product/services.
–The impact your industry’s capabilities and how you supply has on your customers.

As you consider these 3 areas and begin to understand what might be a mafia offer to your customers you must NOT consider that you can’t currently offer certain things. This will stop you before you start.

You may have different offers for your various products/services. To decide which one to develop a mafia offer for first, you can start with the one with the highest T/CU. (See the work book and audio CD Maximizing Profitabilty which covers Throughput Accounting, Goldratt's Theory of Constraints)

Once you have an idea for a mafia offer, then you can come up with all the reasons it won’t work, and see if you can overcome every single one of them. What assumptions do you have about why you can’t do something different?

Mafia offers were orginally discussed in Eliyahu Goldratt's book It's Not Luck.