More and more economists and financial executives are predicting there will be a downturn within the next two years. Although no one is predicting anything close to the severity we experienced in 2008, it will come. What do we recommend you do?
First, look at your working-capital habits. Over the course of this 10-year-plus run of prosperity, many companies started out slowly, keeping their cash use very lean. But as it became very apparent that the sky was not going to fall, many have loosened up their purse strings. We’ve all hired, added and upgraded at least a few positions within the company to take advantage of the growing opportunities. Many have increased their inventory positions to ensure a steady flow of materials. As order and shipment flow increased, our receivable positions may have gotten longer, or customers may have negotiated longer payment terms.
At the same time, some of you may have done the same to your suppliers, while others may have brought payables further into line with their suppliers’ terms.
Whichever of these examples you may have employed, it may be time to review where you are. Here are four things you should review now and make appropriate adjustments.
Cash conversion cycle: This is a basic ratio that every business should know. It is especially applicable to a business that produces goods. This is the total time it takes you to convert the inventory you have bought to cash. It considers how many days that inventory sits on the shelf and gets through your production process, plus the time it takes for you to get paid, less the time you take to pay your vendors. The smaller the ratio, the better your working capital use.
Inventory turns or days: Inventory is an investment or use of cash that most companies grow during times of prosperity. It is also the place you most likely need to reduce your cash use. Put an inventory reduction plan in place now. One system I have found almost universally beneficial is installing a Kanban or pull system for inventory control – “Don’t buy it until you need it.” Maybe start with a min-max system if you don’t trust Kanban but do something. Take the time to understand your position and set targets for improvement.
Accounts receivable days or days sales outstanding: This is the second part of the CCC formula. How long it takes to get paid after you have shipped your product to your customer. Look at your aging report. Every accounting software has one. Anything more than 45 days needs attention. Get your average days as close to your standard terms as possible. Make the calls, review your customer credit lines.
Days payable days or days payable outstanding: The third part of the CCC formula is how long it takes you to pay your bills. There are very different philosophies on whether you should stretch vendors, pay them on time or take advantage of discounts.
I find it is strategically more important to keep suppliers satisfied by paying close to on-time. This helps you to get to the front of the line when you need something from them. Make sure you and your bill-payer are both in alignment with whichever philosophy you use.
Overall, these three areas are the largest areas of cash management you have in your business. Think about the last recession. Inventory was probably your biggest investment and area of focus, followed by your receivables. Start with inventory because it is the area that can stop you cold if you don’t have enough or have too much. Set those targets and get busy.
There are other areas of your business that also need to be reviewed. We especially recommend you pay attention to your sales process, structure and goals.
Don’t wait until the recession is upon you. You need to discuss how these and other business strategies can help you prepare for the oncoming economic storm. Then put the appropriate tactics into action.
Tom Stocker is the managing director of Owner’s Edge LLC, a strategic planning advisory and consulting firm for small and midmarket businesses.
