A Process Of On-Going Improvement (POOGI) - Part 40

We are continuing our series based on The Goal by Eliyahu M Goldratt and the Theory of Constraints. {This series was co-written with Brad Stillahn.}


What to Change to?

As with any real constraint, your overall company only has one of them. For example, your company cannot be both internally and externally constrained at the same time (yes, we are aware that your company is different and more complex). A company that addresses its internal constraint can become externally constrained rather quickly, or vice versa, so synchronized corrective action is important.

For an internal constraint, TOC has logistical solutions for operations, projects, distribution and supply chain. The TOC logistic solutions usually need to be tailored to the company because you are different. Lean and Six Sigma tools can help increase the speed and effectiveness of implementing the TOC solutions.

For an external constraint, TOC has solutions for marketing (Mafia Offers) and sales. For other external constraints, TOC has thinking process tools to help identify the problem and the direction of the solution. Again, these normally need to be tailored to your company.

For a cash constraint, which is a special case of an external constraint, the TOC thinking process tools would need to be tailored to your company’s specific situation.

If you are diligent and effective, whether your company has an internal constraint or external constraint, the TOC solutions are powerful enough to correct the problem in about three months.

Please let us know where your company constraint is: internal, external, or cash. Email your answer to Theory of Constraints ANSWER . We will respond with our recommendation on what to do about it.

As you probably know we recommend strategically placing your constraint. The location of your constraint is a very important issue. Where's yours now and where do you want it to be -- where do you want your strategic constraint to be?

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang
(c)Copyright 2009, Dr Lisa, Inc. All rights reserved.

A Process Of On-Going Improvement (POOGI) - Part 39

We are continuing our series based on The Goal by Eliyahu M Goldratt and the Theory of Constraints. {This series was co-written with Brad Stillahn.}

Are you externally constrained? Yes or no?

Your company is externally constrained if your company (usually) has the capacity to sell more than it does.

We call it externally constrained instead of market constrained because there a many other factors external to the company which may constrain its ability to sell. For example, government regulation is often an external constraint. Credit availability would also be an example of an external constraint.

Being externally constrained is not inherently bad. In fact, an amount of “protective capacity” is necessary to be responsive to the market, have competitive lead times, and meet due date commitments.

Conventionally, a company responds to being externally constrained by cutting costs, especially people costs by layoffs. In some instances, especially when the company is short of cash, this may be necessary. However, contrary to popular opinion and practice, such attempts to “balance” capacity to sales demand is not good management because it directly causes a chaotic work environment, leading to long lead times and poor due date performance.

Are you cash constrained? Yes or no?

Your company has a cash constraint if and only if you have enough customer orders but your suppliers will not supply you their products and services unless you pay with cash upfront.

Approached conventionally, a cash-constrained company will usually go bankrupt because in the short term, the timing of the cash outflows is more than the cash inflows, and the cooperation of the suppliers and customers cannot be achieved quickly enough to prevent the company from running out of cash.

While it is rather unusual to be cash-constrained, recent economic events may result in customers unilaterally stretching out payables and/or banks restricting credit, so a cash constraint can suddenly emerge.

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang

(c)Copyright 2009, Dr Lisa, Inc. All rights reserved.

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.

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.

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.