Cash Velocity Summary

Continuing our cash velocity discussion started on March 16, 2007

Cash Velocity Summary

There are two cash velocity rules:
● Make sure that the amount and rate of cash flowing in is enough to cover all your business and personal needs
● Be paranoid. Unfortunately, stuff happens. And unless you’re willing to risk losing your passion, studying and maximizing your cash velocity is essential
The goal of this chapter was to educate the reader about cash velocity -- how to maximize it and how to avoid cash becoming your constraint. We discussed the two drivers of velocity: throughput and cash-to-cash cycle time. We found that by using Goldratt's TOC techniques, we can increase throughput and reduce cash-to-cash cycle time. We also discovered that the velocity of throughput can be more important than the amount of throughput, especially when we are limited by cash.
If fear of cash problems is not enough for you to monitor, forecast and plan for you cash velocity needs, then consider this: The real value of your business is NOT based on your accountant’s value of your assets; it is based on the cash earning stream that your business assets are likely to produce. The more predictable and reliable this stream of cash is, the more valuable your business is. So if you ever plan to sell your business and retire with the money, then you need to pay attention to your cash velocity. Your banker will also value your business and assess your risk based on your cash flow.[1] Cash is still king. It’s still the life blood. So get in the drivers seat by understanding and increasing your cash velocity.

[1] Many banks use the Uniform Credit Analysis® Cash-Flow Worksheet developed by Wells Fargo and made popular by the Risk Management Association.

That completes the cash velocity discussion we started on March 16 for now. What would you like to hear about?

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

Factoring Receivables Reduces Cash to Cash Cycle Time

Continuing our cash velocity discussion started on March 16, 2007
Yesterday we discussed how offering a discount can reduce cash to cash cycle time and today we will discuss an alternative.

Another approach, which leads to similar results is receivables factoring. Factoring receivables, however, takes about a month to set up in order to provide all the necessary information. They charge based on how long it takes your customers to pay. This is typically in the range of 1 to 5% which is a much better deal than the 20% discount. However they typically pay you 80% of the invoice within 2 days but hold 20% of the funds back until your customer has paid. We usually start with the discount offer then switch to factoring once we can get it set up.

In addition to the above ideas, with DBR Scheduling we can also give preference to customers who pay quickly. Customers who pay quickly are certainly better, as demonstrated above, to our cash-to-cash cycle time.

The shorter lead-times that result from implementing DBR can also allow us to offer shorter lead-times for higher prices depending on our industry. This would be determined during your mafia offer development[1].

... to be continued ...

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

[1] We typically do a Mafia Offer Boot Camp over 3 days. For more information see http://www.mafiaoffers.com/

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.

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.

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.