The Cashflow Challenge

Many businesses claim to have good margins. Paradoxically, all of them have overdrawn credit accounts. They are always short of cash.

Why does this happen?

There are many reasons for it. They vary between companies. Here are the top 2 reasons that are most common to many companies.

1. Too much inventory: Many times, companies have a lot of cash blocked in stocks. They sight many reasons for this. One of the popular ones is that their customers need instant delivery. If this is right, then they need to focus on the right customers and sales process. High inventory is only a symptom. It is an indication of a broken marketing and sales process. If the material is not moving, then there could be other problems. It could be a result of improper customer need analysis and product design.

2. High level of receivables: Many companies focus only on the top line. The incentives of the sales team are based on achieving the numbers. When this happens, they sell material at a higher discount and on credit. Often, customers who haggle for the last penny have low margins in their business or are dominant in their segment. Once a company is trapped with such customers, it is impossible to escape.

If your company is facing these challenges, you need to set the right metrics to diagnose and correct them. Metrics:

1. Monitor the receivable to sales ratio. Ideally, this should be as low as possible. It is difficult to provide one number that suits all businesses. A better way is to reduce it on a quarter to quarter basis.

2. Monitor inventory to sales ratio. While measuring this ratio, segregate inventory into raw material, work in process (WIP), and finished goods. It helps to better diagnose the problem. A high finished- goods to sales ratio needs action in the Marketing and Sales Area. Usually, a higher WIP to Sales ratio indicates poor production planning or product development process. Higher Raw Material could be a result of several factors. I am not elaborating on it in this blog. But the thumb rule is to have it as low as possible.

• Subodh