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.