As a finance professional, whenever I look at a Balance Sheet, my first focus area is Inventory portion of it. To me, apart from operational inefficiency, the biggest sinkhole in any organization is Inventory.
In this entry, I would not address inventory as in a conventional way. To me inventory will encompass, apart from the stockpile of inputs, accounts receivable and accounts payable also. By now, those familiar with financial reporting will understand that I am taking them towards fulcrum of all operational and financial functions – “The Cash to Cash Cycle”.
In my opinion Inventory management has always been and will always be the most critical of all the functional objectives of the business. The importance of same is now more prominent as more and more businesses are attracted towards Lean method of management and are in the process of inculcating lean philosophy into every operational activity of business.
One of the fundamental technique and in almost 100% of instances, the starting point of lean is Value Stream Mapping. It would not be an exaggeration if I say that lean actually views business in entirety as a Value Stream which is undertaken with a sole objective of customer satisfaction. Now if business is viewed as a stream, the operational functions of business are nothing but agents which impel this entire stream.
Once business is viewed from this perspective, this entire stream will only have following components
b) Operational Equipment and
c) Inventories (In form of inputs, Cash and payables/receivables)
There is one thing common in each of the above component. They will add value to stream only and only if they are available at the right time. Unavailability at the right time or availability at the wrong time will be perceived as a waste in business stream.
People and Operational Equipment are subjects in itself and I plan to cover same in later entries, herein we will talk about Inventories.
Just to brush up – When I talk about Inventory, I mean the entire gamut of Inputs, Cash and Receivables/Payables.
Any flab in inventory will upset the business stream like nothing else. Any such flab will ensure that when it is needed the most, liquidity will be out of reach in the stream and thus it should remain one of the main focus area of any CEO or COO in today’s scenario.
If we take bird’s eye view of inventory, we can safely assume that each component of this inventory essentially melts out to liquid cash.
Availability of Business cash or the efficacy of Cash to Cash cycle will be influenced by following indices
a) Uncollected debts from Customers – High volume of accounts payable – This is influenced by Lead to Cash cycle of the business and has a huge value stream within.
b) Cash locked up in inventories – In any function – Raw Materials, Work In Progress, Finished Goods, Consumables, Spares etc. etc. etc. This is influenced by efficacy of supply chain and production process value stream. The more these are synchronized to customer demands, the more will be pull within the streams and it will result in fairly acceptable level of inventory.
c) Volume of Payables to Vendors – Effective cash to cash cycles for suppliers who actually are true partners in the business stream. I can safely say that this is a sub-component of Inventory stream.
In a Business to Business scenario, it is imperative that some volume of inventories is maintained. Although a desired state will be to have a Zero Inventory meaning achieving true “Just-in-Time” in the entire business stream, this is seldom possible. However, there should be a constant endeavor to shorten the entire cycle.
THE PARADOX STARTS HERE
If we examine closely, we will find and we will have to admit that out of the three indices mentioned above, first two are influenced by factors which at times may be out of direct control of business head. In zeal to manage cash to cash cycle and bring it down to a healthier level, the most easily controllable indice, namely “Volume of Payable to Vendors” is influenced.
While a shorter cash-to-cash cycle is generally considered a positive indicator lean business, one need to look deeper to be sure. Shorter or desirable cycle times can be achieved by means which can be counterproductive in longer run.
A business can shave off a considerable portion of its cash to cash cycle if the payables are stretched beyond normal terms, thereby elongating the payouts and retaining liquidity in the stream. Pressurizing vendors to accept delayed payments results in upsetting their own streams which in turn disturbs the whole flow within the business.
To properly evaluate cash-to-cash cycle performance, business manager should evaluate the same in conjunction with other information namely as follows:
- Assignment of Time value: Trend of cycle time is more critical than its value at a single point. If one does not look at trends, he is evaluating only with a short term view which is not a pragmatic approach.
- Measure in against Industry Benchmarks: One needs to look up to the typical cash-to-cash cycle for other businesses in same industry. This needs to be looked upon component by component and only than the scope for improvement in right direction will open up.
- Ethical values of the Business: Shortening of cash-to-cash cycle by squeezing suppliers to accept long payment periods can be counterproductive. Businesses that have size and great buying power as relative to the vendors whose products or services they purchase generally deploy this tactic. The buyer uses its power to control its supplier’s behavior. Such control strategies corrupt the extended value stream of the vendors by pitting components against each other. Such squeezing undermines the viability of vendors and in turn do undermine the supply chain relationships. Threatened and exploited suppliers are provoked to develop a counterbalancing force largely through commercial action that progressively erupts into full blown adversarial relationships.
A more pragmatic approach to improve cash to cash cycle should be to balance the inventory against requirement with an eventual goal to increase Inventory Turnover Ratio. Secondly Kaizans should be applied to improve Lead to Cash Cycles. Rather than squeezing vendors, they should rather be developed as a reliable base to bail the business out in tighter times. This confidence building exercise should be worked upon.