4 steps to navigate your business during the turmoil with better Cash Flows

Coronavirus outbreak has triggered one of the most severe global economic crisis of mankind. It has affected directly or in-directly every being on the earth. Inspire infecting millions, it has brought economic activity to a near-standstill as countries imposed lockdown.

Businesses around the globe have to re-think their strategies to survive this situation. In normal conditions, Income Statement and particularly top-line items like revenue is the hot topic. But in the current abnormal business conditions, companies need to urgently shift their focus from the income statement to the balance sheet with a spotlight on working capital and more specifically to positive cash flows.

“We were always focused on our profit and loss statement. But cash flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas.” – Michael Dell, CEO of Dell Technologies

How Working Capital is linked with Cash flow position?

Yes, working capital and most precisely cash flows are the point of consideration in the current situation. Nobody wants to tie up extra money in running their business. We can understand it from a simple example of an apple juice shop. The shop keeper has to buy fruits, but he is aware that he shouldn’t buy 100 kg of apples at once when he will only use a few kgs per day. He shouldn’t make 50 gallons of apple juice when he will only sell a few gallons per day. He should collect payment immediately from his customers and he should see if he can pay the grocer in a month rather than today.

At the end of the day, making just a juice you’re going to sell (e.g. reducing inventory), collecting money from your customers right away (minimizing Accounts Receivable) and paying your grocer as late as you can (maximizing Accounts Payable) means that you will have extra cash available to do other things like expansion of current business or doing other business.

The simple concepts get complicated when we talk about a national or international business.

How can we strengthen our cash flow position?

Phase # 1 – Initial Assessments:

The logical first phase of any situation is a careful assessment, in this case, we need a thorough working capital assessment. Now it’s time to dive deep into the subject. There are primarily three components in the working capital, i.e.

• Accounts Receivable (the person/business to whom we sell our product)
• Accounts Payable (the person/business to whom we buy our inventory)
• Inventory (the stock in our warehouse, whether in raw, semi-finished or finished form)

Here it is important to discuss the fundamental concept of the “Cash Conversion Cycle” in Working Capital and why it is important for the business.

The Cash Conversion Cycle is a metric that expresses the time (measured in days) it takes for a company to convert its investments in inventory and other resources into cash flows from sales. It is also known as Net Operating Cycle.

The basic idea is to collect the dollar invested in the business as soon as possible which can be explained in the flow chart given below:

Cash Conversion Cycle is important because:

• Shorter Cash Conversion Cycle indicates that the company has to finance its accounts receivable and inventory for a short period of time. This will indicate higher liquidity and effective management of inventory and credit sales
• Longer Cash Conversion Cycle indicates that it takes longer to sell its products and/or receive payments from its customers and/or possibly it is paying bills too quickly

Some of the hints of inefficient payables functions that can represent an opportunity for improvements are

Lack of standardized payment terms

• Multiple payment terms with the same suppliers
• Lack of payment terms approval mechanism
• Increase in payments disputes
• Lack of accurate forecasting of disbursements (cash flow forecasting)

Inefficient receivables functions like some point given below can provide an area of improvements:

• An increasing balance of past due receivables
• A large number of claims and adjustments
• A large number of customer billing/invoicing complaints (disputes)
• Increasing bad debt levels.

In the process of initial assessment, it is also important to

• Conduct Root Cause Analysis to identify the linkage between performance and business goals and objectives.
• Segmentation of clients and suppliers
• Identify the key drivers of cash flow improvement.
• Identify potential benefits
• Identify “Quick Wins”
• Develop business case (recommendations, benefits, and level of efforts with responsibility matrix)
• Implementation Approach

Phase # 2: Win support of Top Management

The support to C-suite (CEO, CFO, CIO, etc) is critical for the success of any project. As the water flows from up to down, therefore the ownership of the top management is important. Sustainable cash flow improvement project (Working Capital Optimization) is up to the firm’s employees so that they

• Understand how their day-to-day activities affect cash flows.  
• Put more focus on incorporating cash flow improvement their duties.

Every time the individual takes an action, he/she should ask “what impact will this have on cash flows?”

Lower-level management must hear this from top management and understand that cash flow improvement is the real focus of the company in their routine meetings.

“What gets measured, gets managed” by Peter Drucker in his book “The Practice of Management”

Phase # 3: Develop Management Reports and Dashboards

The development of management reports and dashboards will allow operating units, other departments, and top management to monitor the development of the cash flow improvement project in a real-time. There are two reasons this is very important:

• It brings a sense of accountability
• People are interested in seeing the result of their efforts.

When the employees will achieve success in quick wins, everyone will want to be involved to create a “Domino Effect”.

Phase # 4: Monitoring and Acknowledgments

Now the monitoring of top and middle management will steer the project, providing guidance and course-correct along the way. The acknowledgment of people will also benefit in the success of such a project.

We need to move toward effective control of cash flows to weather the storm and keep the growth of the business on the right track. Improving cash flows is a hard task but it is the need of the hour. We can unlock the potential hidden cash for the business.

We, at Kaizen Analytics LLP, do exactly the same and can add real value to your business.