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.

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.