"Cash is King", but
only a minor king compared to the customer? This is quite a complex subject but
it is particularly important to get right because of the obvious consequences
if either one of these Kings is compromised. So, not only is this a basic financial
skill, it has to be used in a way that is sympathetic not only to customers but
also to suppliers, the tax man and most important of all, staff. This means
that stakeholder relationship management is an important part of this topic,
particularly where a business is in financial distress.
In the examples shown in that section, I have been instrumental in employing
the following steps alongside that stakeholder relationship management referred
to:
The Cash Operating Cycle
measures the amount of time (in days) that cash is outside of the business. So
after how many days following the payment of a supplier does the business
expect to receive cash from its customer? The answer is "as short a time
as possible", but flippancy aside it is a critical measure in providing an
overview of the speed with which suppliers are paid, the efficiency and
effectiveness of its cash collection operation, and importantly, the adequacy
of its inventory holding. This means that the cycle is more of a working
capital measure than one that is purely about cash.
How is the cycle measured?
The cycle is made up of 3 elements, being the stock turnover days added to
debtor days from which is deducted creditor days.
Stock days are a measure of cost of sales divided by stock, debtor days are
sales invoicing (including VAT) divided by trade debtors and creditor days are
supplier invoicing (including VAT) divided trade creditors.
Different businesses will
have different cycles. For example, a supermarket holds stock for a couple of
weeks, has no debtors and probably pays its creditors after 30 to 45 days. This
would suggest a negative cycle. A transport business is even better - cash up
front with no debtors or stock. However, a manufacturing business may have
debtor days of 55 or 60, it may have to hold stock (raw materials +
work-in-progress + finished goods) for 60 or 90 days and it may get away with
paying creditors after 45. A cycle of 100 days is typical for a manufacturing
business.
Strategic Growth Model
This model
takes the cash operating cycle one stage further by placing it in the context
of the cost structure of the business. The output from the formula is a
compound % indicator that suggests the rate at which a business can grow,
without using or releasing cash, based on its cost structure and working
capital usage.