Working Capital: Putting Your Financial Resources to Work

In the past few weeks we have been covering important elements of finance processes, including internal control systems as prescribed by Sarbanes-Oxley, and the importance of capital planning to ensure key high level financial facets such cost of capital and return on assets

have established goals and are being measured.

Our final topic on finance processes is about working

capital. Working

capital is the money it takes to run your business on a daily, weekly, and m

onthly basis. It is the money used to pay your suppliers for

materials and the money needed to pay for the goods and services (i.e. inventory and payroll) you have used while you wait for your customers to pay you.

There are three important areas that companies should actively manage

in order to get the most from their working capital. Here’s how they

are related:

working capital = accounts receivable + inventory – accounts payable

Accounts Payable

Accounts payable is perhaps the easiest process to control because i

t simply involves paying the bills. But paying bills shouldn’t just be left to chance; there should be clear policies and goals that direct these activities. But generally, when it comes to paying bills, The Golden Rule should apply. Treat others’ invoices as you wish others would treat your invoice. Basically, that means pay it on time according to the terms. There may be no advantage in paying early, but purposely paying late as a working capital management tool is unprofessional and can negatively impact your business.

You may think you are getting away with paying your bills late

, but in reality, if the organization y

ou’re paying late has their act together, then your delayed payment may eventually result in increased prices or reduced service levels. While you may be the customer, do you really want to run you business in a way

that elicits frowns and curses when your name is mentioned? Building such a negative reputation can have long term detrimental repercussions.

Ensure you policy states that payment will be made according to terms, with a goal of mailing payment five business days prior to the due date or having funds transferred on the due date for electronic payments (and a supporting measurement that clearly indicates performance in relationship to th

e goal). The accounts payable policy should also clearly state when invoices should be paid early.

Effective Annual Rate of Return

Is a 2% reduction in the invoice amount enough of an incentive to pay within 10 days? Typically it is, as paying early for a 2% reduction can result in a 37% return. The important issue is that accounts payable policies are well thought-out (in terms of overarching working capital goals) and followed through with objectives and measurements.

Accounts Receivable

The cash flowing into your business as a result of customers paying invoices is crucial in managing your business’ working capital. Your organization s

hould be actively measuring Days Sales Outstanding (DSO). DSO is the average number of days it takes to collect payment after the sale was made. Typically calculated as [(Accounts Receivable / Sales) X (Days)]. Days would be determined by

the period for which you are calculating DSO; for

example 30 if you cal

culate it monthly and 90 if you calculate it quarterly.

One key to managing Account Receivable is to remove delay in invoicing customers after shipment of an order or delivery of a service. These delays consume cash available as working capital. Set a goal to invoice custo

mers immediately after fulfillment. If it currently takes 10 days to invo

ice a customer, then the goal should be to do it in 5. If it currently takes 5 then the goal should be 2 days. Finding ways to reduce the DSO frees cash formally tied up in receivables so it can be used in ways that provides return and fuels growth.

Prompt invoicing is the most important method to reduce DSO. It is something you have direct control over, plus, why should customers be conscientious about paying your invoice in a timely way if your make little effort to send invoices promptly?

Inventory Management

Including inventory as a finance function sometimes causes confusion and skepticism. There is no doubt, however, that inventory consumes financial resources; whether in the form of purchased materials/parts, work-in-process, or finished goods. Those responsible for managing the company’s financial resources and performance should also have the ability to oversee and monitor all three types of inventory.

The purchasing representative might believe they are getting a good deal by buying one years worth of parts, and perhaps they are. But making such decisions impacts the overall financial resources consumed by inventory, especially when you include the cost of ownership.

The responsible financial authority should stay informed of inventory performance, and in response set clear policies and goals for reducing and managing inventory levels through metrics such as Inventory Turns (the number of times that a company’s inventory cycles or turns over per year), Days Inventory (the average number of days of inventory on hand per accounting period), Average Inventory (the starting inventory number at the start of a period minus the ending period inventory number divided by 2), and Cost of Ownership (the total cost of maintaining inventory such as warehouse space including utilities and maintenance, finance costs, personnel, equipment, shrinkage, obsolescence, and insurance).

The overarching goal should be to find ways to reduce all types of inventory while ensuring operational needs are being met. This, as with accounts receivable, releases cash tied up in non-productive means so it can be used to gain return or grow the business.

Managing the working capital processes is just as vital to business success as producing products and services that customers want and that fulfills their expectations. Businesses not actively managing their working capital may find an exorbitant amount of financial resources being consumed in unproductive ways such as growing accounts receivable amounts and hefty inventories.

Keys to Improving Business Success

Question: Why is due diligence and transparency important?

Due diligence means you are collecting the proper information and ensuring you are aware of all the relevant facts. As the term transparency implies, it means there is a degree of openness and honesty. The recurring theme of October’s articles illustrate how important due diligence and transparency can be to business success.

Manage Your Business Banking Relationship

Part of financial due diligence in operating a business is having a financial representative (i.e. Owner, CFO, Controller, Business Manager) meet regularly with a bank representative. Prior to the meeting, create a

n agenda of topic areas. These should include things like:

• Future financial needs for expansions or acquisitions, like lines of credit or loans
• Best use of cash accounts like sweep accounts to maximize return and minimize expense
• Short and long term investment options for a practical liquidity tree
• Use of merchant accounts

Plus, in these times it may not be a bad idea to discuss the bank’s liquidity and financial stability, esp

ecially if you have money in non-insured accounts. Be prepared to ask questions that require details, not unresponsive platitudes. The bank sure doesn’t hesitate to grill you about your business when the money flows the other way.

Is Sarbanes-Oxley Improving Corporate Governance?

Again we find ourselves in middle of economic turbulence due in a large part to a lack of business ethics and sound business practices. Without the necessary transparency and due diligence, lies and deception can go unchallenged, particularly when people are being dishonest with themselves.

But wait a minute! Wasn’t Sarbanes-Oxley supposed to put an end to all that? Aren’t public com

panies, financial or otherwise, supposed to have internal control systems in place as well as checks and balances to prevent

unrealistic, overly optimistic projections and reporting? Obviously, though well-intentioned, SOX has not been as effective as it should be in preventing fraud, abuse, and intentional ignorance. Also, it apparently has not been successful at encouraging organizations to implement effective financial internal control systems and improve corporate governance.

Managing Financial Strategy Means Business Success

A clear strategy and plan not only incorporates goals and the activities needed to reach these goals, but it also addresses risks. Obviously, the risk of handing out loans for hundreds of thousands of dollars without t

he proper due diligence and transparency was not accounted for in managing the financial strategies of those lending/financial organizations now failing or on the brink of failure.

On That Note;

Answer to the question: Due diligence and transparency are important because being aware of the facts and avoiding deception (including deceiving yourself) can mean the difference between success and failure; between staying in business and going out of business. The current state of financial crises may have been avoided if those in charge of banks, lending institutions, regulatory offices, and even elected officials would have exercised appropriate due diligence and transparency.

Effective Policies and Procedures: The Complete Cash to Cash Cycle

Final in Cash to Cash Cycle Series

In the last four posts, we’ve brought to light four key areas in which you can save $250,000 each — for a total of $1,000,000. Point by point, we’ve shown you just how cash flows through these areas, making up the Cash to Cash Cycle.

And as we’ve seen, the cash cycle is undoubtedly the single most important process to optimize for any business – from when you spend money to when you get money.

So now let’s put it all together.

Cash to Cash Cycle Definition

By definition, the cash to cash cycle is a financial ratio that shows the length time for which a company must finance its owninventory. It measures the number of days between the initial cash outflow (when the company pays its suppliers) to the subsequent cash inflow (Accounts Receivable).

Cash Conversion Cycle and Cash Flows

One way to express this is the length of time between the purchase of Inventory (raw materials, etc) and the collection of accounts Receivable created from the sale of your product — also called the cash conversion cycle.

Why is this most important? Because this is your cash flow and because;

Operations Assessment and Working Capital

Businesses live and die by the cash generated from operations. If your operations don’t create cash, then they consume it. A cash-consuming operation means that you have negative cash flow and you are living on financing (debt or equity). But the Cash to Cash Cycle also shows you the amount of working capital you have committed to your organization.

Just add the number of days of inventory to the number of days of receivables outstanding, and then subtract the number of days of payables outstanding. The result is the number of days of working capital your organization has tied up in managing your supply chain. This can be quite a significant number – one not to overlook.

This can also be expressed by the formula: stock days plus debtor days minus creditor days equals the cash-to-cash cycle.

So, for example, a company that keeps its stock for on average 30 days, gets paid by its debtors on average within 30 days and pays its creditors on average within 30 days will have a cash-to-cash cycle of 30 days.

Companies that receive cash from their customers at the point of sale and that have their inventory under good control will have a short cash-to-cash cycle. A company could even have either a negative cycle or a cycle time of zero. For example, if a business’ receivables and payables are held in check at 30 days while inventory runs at Just-In-Time (JIT) levels, then the cash cycle is zero – meaning that this company is in good shape with no working capital needs. And, of course, when receivable days are less than payables with JIT inventory, then the company will enjoy a positive cash-to-cash cycle – creating more cash on hand.

On the other hand, however, if a company puts payables down to 15 days and allows receivables to grow to 45 days, while inventory remains at steady levels, the cash cycle will be high. And. here, working capital will be constrained to compensate for inefficiencies.

Processes and Procedures Investments

Did you realize that working capital is the investment you are making in the inefficiencies of your processes and procedures plus your investment in your suppliers’ and your customers’ inefficiencies too? In other words, if you do not monitor inventory, accounts receivable, sales and marketing and accounts payable to ensure a healthy cash-to-cash cycle, then your working capital needs will not maintain a strong cash flow. The process will be out of control, and will not be optimized to create the greatest amount of financial effectiveness for the company.

Policies and Procedures Savings

So now you can see the relationship between your cash flow, your working capital and your cash to cash cycle. In order to increase your cash flow, you need to increase the velocity of your cash to cash cycle by reducing the inefficiencies found in your processes, your suppliers’ processes and your customers’ processes. The result is a decrease in your working capital and an increase in your cash. And, as we’ve seen, this can be a significant number – again, one that you shouldn’t overlook.

Strategies for Writing Accounts Payable Procedures

The “finish line” — the $1,000,000 “prize”, cash savings for your business – is within sight. In our articles on Inventory andAccounts Receivable, we found $250,000 worth of savings in each functional area. We found another $250K could be saved in Sales and Marketing. Accounts Payable is

the final process in the Cash-to-Cash Cycle — the source of thefinal $250K.

The cash cycle – from when you spend money to when you getmoney – is undoubtedly the single most important process any business can optimize.

Completing the Cash-to-Cash Cycle

So, let’s tie this to accounts payable – the event that pays for the liability incurred by purchasing, which is for inventory required by manufacturing to meet demand. Sales generate this demand that creates the accounts receivables, which is turned into cash, and we have come full circle and completed the discussion on the cash to cash cycle.

Increasing the Velocity of Accounts Payable Processes

Your accounts payable is a bit different than the other processes we have examined so far. The first three processes we looked at represented processes where the focus was on reducing the size of assets (inventory or accounts receivable) or expenses (marketing) and increasing the velocity or cycle time. In accounts payable our focus is on increasing the size of assets while maintaining a solid credit rating and increasing the process velocity.

Now, let’s look at how to find $250,000 in accounts payable savings. If your organization has $500,000 in accounts payable each month…STOP! We can find $250,000 in savings right here! ”Where?”, you ask. Increasing payables by 25% will produce $125,000 in cash plus $125,000 from automating tasks, taking more discounts, and managing the processbetter.

Service Business Procedures Case Study

An organization with $600,000 in monthly payables needed assistance. We examined their payables process to understand and quantify workflow, paper processing, and credit issues, then designed and implemented a process to increase their use of payables and discounts, improve their payables cycle efficiency, and tie it to their purchasing and receivable cycles. We then reinvested $50,000 back into an Enterprise Resource Planning (ERP) program to automate some of the processes that weren’t automated already.

The metrics we developed reduced their purchasing and payables expenses by 25% and increased their efficiency from 50% to 75% within 2 months of implementing the new procedures. With these new processes and reports, the company now tracks payables cycle efficiency and average days payables, rather than just bills paid on time or outstanding balance as the measure of their payables effectiveness. The result: an extra $300,000 in cash, plus a 50% increase in process capability (capacity).

But…how?!

Methods to Help You Design Your Accounts Payable and Accounting Procedures

• Eliminate Paper. The single biggest cost for any purchasing and payables department is paper, including: purchase orders, purchase order follow-up, small-dollar purchases, delivery tracking & receipts, and vendor payments. Utilizing paperless invoices, Web-based supplier self-servicing, centralized vendor files, automated workflows for electronic or imaged invoices (see ERP below), and payment methods, such as business credit cards, Electronic Data Interchange (EDI) and Electronic Funds Transfer (EFT), can reduce paper handling costs by as much as 90%.

• Integrate ERP Systems. Enterprise Resource Planning (ERP) automates the purchasing and payables functions, which allows a company to get more work done with fewer personnel. Also, electronic invoice matching applications save time in retrieving paperwork. It is estimated that an ERP system can annually save an organization $300 per million in sales.

• Increase Payment Terms. Negotiate payment terms based on receipt of goods or the invoice. This can add one week or more to your terms, which can be 25% of 30 day terms. Use EFT for just-in-time payments to maximize your payables terms and minimizing the impact to your credit.

• Take Payment Discounts. If you are getting 2%/10 net 30 terms, then consider taking it. This means you are offered a 2% discount if you pay within 10 days, instead of the normal 30 day terms. This translates into an 18% return on your capital, and for many organizations this is a good return on your investment.

• Review Purchases. Purchasing is a continuous process that requires continuous review. Consider: transportation charges, expedited fees, odd lot penalties, new pricing, new products, consolidating vendors, new vendors or buying groups, payment terms, and more. Communicate with your suppliers to improve the process. And review and monitor everything to account for changes in your environment.

• Communicate with Suppliers. Communicate with your suppliers to improve the process. Ask suppliers to submit their invoices electronically. This will save you time, resources and losses due to waste.

• Eliminate Disputes. Disputes with your suppliers are typically the result of a problem with your purchasing/receiving process. When disputes occur, review your purchasing procedures to ensure that they are producing the correct metrics and that you are not forced to pay for your mistakes.

• Reduce Errors. Overpayments, payments made to the wrong vendors, fake invoices, or even late payments represent a common problem for payables. Increasing your focus on error control, along with written procedures and audits, can reduce these errors considerably.

• Train Personnel. Provide your accounts payable staff with regular formal training. This will arm them with better knowledge of frauds, negotiating skills, and an understanding of the economics of payables, which will result in improved effectiveness.

Accounting Policies and Procedures for Cash in the Bank

In the preceding articles in this series, we showed you three parts of your financial statements that will each contribute $250,000 in cash savings. The last hurdle was Accounts Payable, and we sailed through it. And now we have crossed the finish line and achieved our goal: $1,000,000!

Time was – is – the key. All you have to do is own it.

In the next post we’ll put together the four parts of the cash-to-cash cycle and look at how they affect the working capital of your business.

Take Control of the Sales and Marketing Cycle

We’re sprinting toward that $1,000,000 mark…and we’re only a couple strides away;

Decreasing inventory carried us over the first hurdle, and last week reducing Accounts Receivable sped us through the half-way mark. We’re making great time, so let’s bring on the next mile marker – marketing and sales.

Increasing Overall Sales and Marketing Effectiveness

If you are an organization spending $500,000 or more on marketing expenses (e.g. advertising, trade shows, print materials, direct mail, etc.) then STOP! We found it again. Why you ask? Because marketing has the greatest potential of being veryunproductive.

In fact, many marketing programs struggle to break even, and actually frequently lose money. So if we increase the overall effectiveness, then we can eliminate 50% or more of your wasted marketing efforts, which translates into $250,000 in cash.

So now, let’s see how this actually works in a real-life scenario.

Sales and Marketing Case Study

An organization with $500,000 in marketing expenses needed assistance. We examined their sales and marketing process to understand and quantify the lead flow, follow-up, and demand forecasting issues. Then we designed and implemented a process to improve their sales cycle efficiency and tie it closer to their customer’s buying cycles. After the marketing reductions, we then reinvested $100,000 back into new processes for public relations and Customer Relationship Management (CRM), both of which were suffering badly.

The metrics we developed reduced their marketing expenses by 60% overall and increased their sales cycle efficiency from 40% to 60% within 6 months of implementing the new procedures. With these new processes and reports, the company now tracks sales cycle efficiency and life-time value rather than just sales quota achievement, as the measure of their sales & marketing effectiveness. The result: an extra $300,000 in cash plus a 50% increase in process capability (capacity).

As we have seen time and time again, time can be our best friend, if only we let it.

Methods to Design the New Sales & Marketing Process

• Improve Follow-up. Only about two percent (2%) of sales occur on the first contact. Eighty percent (80%) of sales will require five to eight contacts before the sale closes. This means that if you are contacting the prospect less than five times or more than eight times, then you could have a problem with follow-up.
• Sales Cycle Efficiency. Time kills deals. The speed at which a prospect is converted into a customer and the number of prospects required to make that conversion determines your sales cycle efficiency. So ask yourself, are you taking the right steps to measure and reduce lost sales?
• Life-Time Value. How profitable a given customer is over time defines your LTV or Life-Time Value. Companies spend ten times more to acquire a customer than to keep a customer. However, existing customers are more likely to purchase again, spend more money, and therefore become more profitable. If you don’t know your LTV, then how do you know how much money to spend and on which customer segment?
• Demand Forecasting. Every customer buys on a cycle. So this means that you should track cycle times and variance to increase the accuracy of your forecasting and the loyalty of the customer. Do you know when your customers need to reorder?
• Improve Lead Quality. Do you have methods in place to measure the conversion potential of each lead? Lead generation activities (i.e. forms) should pre-qualify every new lead so that you can take the right follow-up actions for the marketing offer. Strong leads produce strong sales.
• Increase Awareness. To keep the sales pipeline full of good quality leads you must continuously increase the awareness of your company and the solutions that it provides. Public relations is more efficient at building awareness than advertising, yet many companies spend wildly on advertising and trade shows while neglecting to fund public relations efforts much at all. Increase your name recognition, not your budget.
• Reduce Discounting. Discounts represent deficiencies in the sales & marketing processes, which means that you should use them sparingly. Instead, determine the root cause and then fix the process that’s causing the need to discount. Show customers the added value, and they won’t focus on price.
• Train Personnel. Provide your sales & marketing personnel with regular formal training. This will arm them with better product knowledge, as well as presentation, negotiating and selling skills that will improve effectiveness. This will boost both employee morale and the bottom line – a win-win.

Take control, Take control, Take control

Improve your sales cycle efficiency. Reduce your marketing expenses. Tie it closer to your customer’s buying cycles. And take control of your sales and marketing procedures to let them work for you.

With well-defined processes and procedures in place, you will increase efficiency by reducing ineffective sales and marketing programs. And, again, we make such improvements to create more cash on hand – all toward that $1,000,000 goal and to cross the finish line.

Next part, we will hurdle the final $250,000 mark with the Accounting Payable function – so close you can see it.

Strategies for Writing Accounts Receivable Procedures

Laying the Foundation

Last article, we raised the question, “What could your business do with an extra $1,000,000?” To lay the foundation, we introducedinventory as the first of four areas that will lead toward our million-dollar goal. And you saw exactly how to achieve the first $250,000 in cash savings by avoiding delays with an increase in velocity, as well as an increase in discipline and competency. But how exactly? With time, as you saw with inventory and as you’ll see this week.

Tackling Accounting Procedures

Let’s continue that crucial theme of time with another major source on your balance sheet; specifically, accounts receivable, or “A/R”. If you have $500,000 or more in accounts receivable…STOP right there! We have found it again.

Reducing Average Days Collection

Why? Because if we focus on reducing your average days collection by 50%, your accounts receivable balance will fall to $250,000. The result? An extra $250,000 in your bank account! Just like that, we’re halfway to our $1,000,000 goal!

Let’s see how this would work in a real-life business scenario.

Accounting Procedures Service Business Example

A service organization with $700,000 in average A/R balances needed assistance, so we examined their A/R function to understand and quantify the workflow and workload issues. Next, we designed and implemented a process to improve A/R performance.

The metrics we developed reduced their “over 60″ accounts receivables by 85% and their overall A/R balance by 50% within 90 days of implementing the new procedures. With these new processes and reports, the company now tracks Average Days Collection and past due rather than just Days Sales Outstanding (DSO) as the measure of their collection effectiveness.

The result: an extra $350,000 in cash! Again, it’s obvious what a crucial role time plays and how an increase in velocity and discipline directly lead to increases in efficiency and cash savings. So, how can you use time to your advantage?

Methods to Design the New Accounting Process

Decrease collection cycle. Examine customer accounts that go beyond your terms. Do not wait until twice the net terms to take action.

Tighten credit policy. Examine credit process for slippage. Do you have a credit approval process? Do you perform credit checks? What standards are used to extend credit?

Reduce credit terms. Change the credit terms you offer your customers. If you offer terms of net 45, reduce it to net 30. You might offer a discount of 1% if paid within 10 days else net due in 30 days. This is equivalent to 18 % annual interest and most businesses will take those terms.

Shorten the invoice process. Bill your customers immediately. This is a big one. Many service organizations wait until the end of the month to tally billable hours and determine customer charges. Do not wait until the end of the month. This could reduce your day’s receivable by as much as 15 days right there. Email or fax your invoices to save another day or two (e.g. QuickBooks accounting software contains this feature).

Reduce billing errors. Most customers delay payments because of invoice errors. Customers won’t recognize the invoice until it is corrected and may not even notify you, the vendor, of the error until you call for collection. Again, avoiding this delay in error and time will amount to cash savings.

Train Accounts Receivables personnel. Make sure that all personnel involved are training to understand the performance metrics for their jobs. For example, a company will manage $500,000 in monthly A/R balances (that’s $6,000,000 per year!) using an A/R clerk who makes $30,000. But then the supervisor uses nothing more than On-The-Job (OJT) training for the clerk. Then the CFO thinks that he or she (the CFO) is really managing the money. But, in reality, that’s not the case; the clerk is managing the money day-to-day. So shouldn’t the A/R clerk receive enough training to manage such a significant amount? After all, it only takes a 6% change in A/R in one month to equal the A/R clerk’s entire annual salary. Isn’t the A/R savings worth a little extra time in training?

Maximize the Accounting Process. With the Accounts Receivable department you should use each element of the process to gain the most benefit for your business. And with time-saving procedures set in place, you will let your efficiency work for you.

Grabbing Your Policy Goal

With well-defined processes and procedures in place, you will increase your efficiency by reducing your Average Days Collection. And of course a reduction in Average Days Collection means your A/R balance will also fall, creating more cash on hand. And already we’re halfway to our $1,000,000 goal!

In the next postt, we’ll look at finding yet another $250,000 in the Sales function. That will get us three-fourths of the way to our goal of $1 million in cash savings. Not only do you reap rewards in extra savings to your bottom line, but you also see more cash in the bank.

Inventory Procedures Find Capital in Your Business

What Would You Do with $1,000,000?

With $1 Million would you:

• Pay off debt?
• Purchase new equipment?
• Invest/save for the future?
• Give yourself a bonus?
• Buy a new car, boat or plane?

$1 Million Waiting in Your Wings

What do you and your business need that you have been putting off because you don’t have the money today? $1,000,000 certainly would fill those needs. But where do you find $1 Million just lying around your business right now? Well, you probably have $250,000 in each of four areas in your everyday business, and you don’t even realize it.

Money in Your Business Procedures

So let’s look at four places in your business where we will find $250,000 each and see how we can help you find it:

• Part 1: Inventory – $250,000.00
• Part 2: Accounts Receivable – $250,000.00
• Part 3: Sales – $250,000.00
• Part 4: Accounts Payable – $250,000.00
• Part 5: How-to Procedures – $1,000,000.00

Turn Time into Cash with a New Company Policy

But just what exactly is this source for cash? It’s time. If you are looking for $250,000 then it costs you $4,808 every week that you delay. So what you do with your time quite literally amounts to either costs of delaying, or it can amount to savings when you take action and control of your time. To correct this cost of delay, an increase in velocity must follow – which will set the difference between ‘good’ and ‘great’. The consequences of this shift in system velocity increases discipline and competency: the ability to maintain the increased velocity and the ability to make the adjustments to achieve the ‘great’. So how do you realize the difference?

Eliminate Inventory and Increase Cash

Let’s start with the biggest, most obvious source – your balance sheet, specifically inventory. If you are a manufacturer with $300,000 or more of inventory (raw materials, work in process or finished goods) then STOP! We found it. Why? Because inventory is an unproductive asset. Inventory is money, and having it lying around your factory is not where your money belongs. So if we reduce inventory to Just-In-Time (JIT) levels, then we can eliminate 85% or more of your inventory, which translates into $250,000 in cash. But that’s not all. You will also save another $50,000 or more in annual inventory carrying costs. With less inventory, there are lower costs of holding inventory. Let’s look at an example of what we’re talking about.

Manufacturing Business Procedures Case Study

A manufacturing organization with $2 Million in average inventory balances needed assistance. We examined their inventory consisting of raw materials, work in process and finished goods to understand and quantify the workflow, workload, and demand forecasting issues. Then we designed and implemented a process to improve their inventory cycle and tie it closer to their actual sales.

The metrics we developed reduced their inventories by 85% and increased their manufacturing cycle efficiency from 60% to 90% within 120 days of implementing the new procedures. With these new processes and reports, the company now tracks manufacturing cycle efficiency and delivery time variance rather than just units produced, as the measure of their manufacturing effectiveness. The result: extra capital plus a 50% increase in process capability (capacity).

Methods to Design the New Process

By becoming more efficient in the process, we can use time not as a detriment but as a significant benefit to our business. Step by step, let’s take a further look at how time and efficiency plays a great role in your business.

Increase Demand Forecasting Accuracy. We only need enough inventory to satisfy demand, and that is where part of the problem exists. If demand can not be accurately forecasted, then we end up compensating for this unknown with inventory.

Increase Manufacturing Cycle Efficiency. How well manufacturing resources are used to produce a product determines the cycle efficiency. Defective product, product rework, and long lags between manufacturing cells cause inefficiency, which can be easily calculated. Raw materials should be converted into finished goods as quickly as possible. The speed at which this occurs defines your manufacturing cycle efficiency.

Increase Supply Chain Turns. Increasing the number of times purchases are made may increase acquisition costs and unit costs because of smaller order quantities. But you will benefit by increasing your cash flow and eliminating the carrying cost of the inventory (warehousing, material handling, taxes, insurance, depreciation, interest and obsolescence totaling 25% to 35%).

Eliminate safety stock. Safety stock is really just a buffer for forecasting variance and supplier delivery time. While many levels are set arbitrarily in automated MRP systems, your safety stock levels will need to be reduced due to improvements in demand forecasting accuracy, manufacturing cycle efficiency and supply chain turns.

Reduce purchasing errors. This can reduce overstocking and, more importantly, minimize stock outs that result in expensive expedited purchases. Sell excess and obsolete inventory or return it to your vendor.

Eliminate delivery variance. Do not allow vendors to deliver early or late and make sure the delivered quantity does not vary from the order quantity. After all, delivery errors cause the need to carry more inventory. Instead, provide suppliers with forecasts of future needs.

Train purchasing personnel. Provide your purchasing and material management personnel with formal training. This will arm them with better negotiating skills that will result in better prices and terms.

Procedures Provide Time Savings

So, as we have seen, we should use each element of the process to extract the most benefit from our business. With time-saving procedures set in place, you will let your efficiency work for you.

Time Savings Provide Cash in the Bank

With well-defined processes and procedures in place, you will increase efficiency by increasing inventory turns. And of course an increase in inventory turns means an increase in cash on hand. It’s there – all you have to do is grab it.

Next Post-Save 250,000 in Accounts Receivable