Understand the connection between the profit and loss (P&L) statement and the cash flow statement.
- Cash Conversion Cycle (CCC) = Sales Outstanding - Payables outstanding + Inventory
Improve your CCC:
- Use inventory postponement and package on demand in plants and warehouses. Hold inventory at a work-in-process (WIP) level in the bill of materials (BOM) and differentiate when you get an order. This limits the SKU's you have to hold in inventory on and hence you can hold less inventory. For example, if you are selling identical items to different retailers in different packages, hold the inventory prior to packaging it (a lower level in the bill of material) and pack it on demand.
- Supplier-owned managed inventory initiative in the plants. Urge your suppliers to manage and own the inventory in your plants. Your competitors probably do this. This is quickly becoming not a differentiator but an order qualifier for many suppliers. The idea is not to shift the inventory upstream but to make your suppliers work with you to reduce it. Once they have it, they will work with you on reducing it.
- Cross docking in warehouses. Use a third-party logistics (3PL) provider to synchronize the inbound and outbound movements out of your warehouses. The idea is to never take possession of inventory, but just receive it, turn around and ship it on another waiting truck. Most 3PLs have built this expertise, which was once the forte of a few pioneering companies.
- Apply simple ABC analysis to analyze inventory. Identify As, Bs and Cs by value (volume x cost/unit). Control your As (make every A every day or week, depending on cycle times), and loosen the Cs (which are usually the problem children) to balance investment with service levels. This will reduce inventory as well as improve service levels.
- Define what to make to order and what to carry in stock. A lot of companies by default make everything to stock just because they have always done so. Institute a program that looks periodically at the profitability, velocity and volatility of inventory by SKU. Based on the analysis, make decisions on what to make to stock and what to make to order. As a rule, make to stock the higher velocity, higher margin SKUs. Demand a higher price and lead time for slower-moving and lower-margin products, and make them to order.
Are you bleeding cash?
- Understand the cash inflow and outflow impact — or, in other words, the difference between speed of payment to your supply base and speed of collection from your customers. Supply chains play a key role in optimizing or suboptimizing the accounts payable and receivable cycles for companies.
- Analyze the gap between account receivables (A/R) and account payables (A/P) by company and each SBU if financial reporting permits. You may be surprised to find out that you are paying out faster than you can collect and hence bleeding cash — or borrowing at high interest rates to keep the business going.
- Create the recognition that a day of payables is worth much less than a day of receivables, as there is value added for conversion and then a margin on top of it. This results in the required payables cycle being much longer than the required receivables cycles to net out on cash flow. For example. It's not OK to have 30 days of payables if you have 30 days of receivables. To equal 20 days of receivables in value, your payables probably need to be at 35 days. This actual calculation will depend on your company's conversion and margin structure.
Make AP greater than AR