Managing the cash cycle
Getting control of your cycle time in this era of sparse credit is a key way to reducing costs in your business – it can mean the difference between success and failure.
What is "cycle time?”
Cycle time is best defined as: "The total time in business it takes from receipt of an order until payment is received and banked.”
In many businesses the cycle time is typically 90 days. In some cases it is much longer. For complex projects payment can be staggered over many years and final payments are often withheld for a guaranteed period, extending even further the total cycle time.
Negative cycle time
Some businesses have a negative cycle time; that is the money is received and banked even before the goods or services are delivered. Airline tickets or pre-paid phone cards are typically negative cycle time businesses, so too are online sellers such as Amazon. Indeed in the latter case there is not even a need to have expensive infrastructure, such as in the case of a telco or an airline. Amazon as a business needed nothing more than a PC and a website as its investments to get started and create a negative cycle time business.
"Cycle Time” can mean the difference between success or failure
It is important, especially in smaller businesses, to understand the influence cycle time can have on success, or perhaps failure. Indeed there are many stories of business that have failed because they grew too fast and were unable to provide the finance to support that growth.
In simplistic terms, if a business is shipping $100,000 per month and is operating on a three-month cycle time, a minimum of $300,000 is needed to finance the operation. Banks, especially these days, are loath to finance businesses against orders, but rather look for bricks and mortar assets as collateral.
If suddenly the business now starts shipping $200,000 per month with the same cycle time, $600,000 is now needed as working capital, and if that is not available, then foreclosure may be staring you in the face.
However, if the same business can reduce its cycle time to just 1.5 months, then sales of $200,0000 can be supported with the same initial equity base. That’s how important cycle time is, but unfortunately, this is often overlooked.
Customers are slow to pay
Doubtless the greater part of cycle time is the delay in customers paying their debts.
Whilst we can push for deposits, short term financing or even early payment incentives, we should not ignore the in-built delays inherent in our own internal processes. If these can be identified and rectified any reduction in cycle time will be immediately seen on the bottom line as pure profit.
So what’s the solution?
Some businesses look to "factoring” their debts. This essentially means taking a short term loan for the period of financial stress, but in many cases the interest charged is sufficient to wipe out any potential profits. Thus, whilst factoring does have a place, look closely at the costs before seeing this as a panacea.
Yet another means is to offer discounts for early payment.
Unfortunately, whilst both of the above may improve cash flow somewhat, they come at a cost.
A better solution to gaining a partial reduction in cycle time is to the take immediate deposits on a customer’s placement of an order. Deposits from customers are seldom seen as your ploy to gain some payment a little earlier, but more likely embraced by many as a means to secure their place in your delivery queue, and thus they are not viewed negatively.,
The best solution is to analyse your entire business cycle time. This is best done by dissecting the business into its serial components from receipt of an order, to shipment and debt collection and to look for ways cycle time can be reduced.
Process Innovation is one way of investigating cycle time in a systematic manner. It is quite amazing what effect small changes to processes can have in delivering real cycle time reductions, and any gains made here go straight to the bottom line as profit, pure and simple.
What’s the message?
Process Innovation applied to the cycle time reduction should be seen as a means to reap hidden profits from transactions that may otherwise cost real money. Dissect and analyse your business, there is always room for improvement.
Roger La Salle, is the creator of the "Matrix Thinking" technique and is a widely sought after as an international speaker on innovation, opportunity and business development.
InvestSMART FORUM: Come and meet the team
We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.
Want access to our latest research and new buy ideas?
Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.Sign up for free