kanvic you have got cash! know how to free it up

8/8/2019 Kanvic You Have Got Cash! Know How to Free It Up

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You have got cash!Know how to free it up



You have got cash! Know how to free it up.

Managers are aware that extra cash may be tied up in inventoryand receivables; yet they are not able to free it up. By adopting asystematic approach, exercising more discipline and providingright incentives, they can free up extra cash and reduce theirworking capital requirements.

by Ravindra Beleyur


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Sales become more important in a growing

economy than managing cash well. As a

result, many businesses need more cash

than required to run their operations. It is

easy to get more credit in good times butsecuring more working capital during an

economic crisis is not as easy. No doubt,

the situation has improved but banks and

other financial institutions still need to

loosen their purse strings.

The recent financial crisis has made

businesses introspect and take drastic

actions to keep the wheels roll ing.

Managers have learnt that cash is king

during recession. However, cash always

needs to be managed well- in times good

and bad.

It is not uncommon to hear that cash is

locked up in inventory and accountreceivables (Exhibit 1). But, without looking

for ‘cash sinks’ in their business, managers

try to make up for the shortfall by

additional finance from banks or other

sources. Many a times, they also end up

delaying payments to the suppliers.

This article presents the reasons why

businesses find themselves in cash crunch

situations and what steps they can take to

improve such a situation.

Ravindra Beleyur ([email protected]) is cofounder and a partner at Kanvic where he leads corporate

finance practice.

mailto:[email protected]






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Looking for cash culprits

Getting to the root of the problem is an

important first step towards improving cash

situation. Lack of discipl ine, wrong

performance metrics, system gaps and even

a tendency to avoid bold decisions can lead

to more cash tied up in inventory and

receivables. We look at some common cashculprits in the following pages:

Gaps in demand forecasting

Effective demand forecasting plays an

impor tant ro le in bett er invent ory

management. While stock-outs have a risk

of losing sales, excess stocks build up

inventory blocking cash in turn. There are

many instances when demand forecasting is

done at product line level but gaps emerge

at product level or SKU (Stock Keeping Unit)

level. This becomes more pronounced in

case of products which have a very long

manufacturing cycle time.

For new products, managers struggle to find

right benchmarks to forecast demand. This,

coupled with their overoptimism with new

product, results in excess stocks in many

cases.

Exhibit 1 Where is your cash?

Cash

Accountsreceivable

Raw material

Inventory Work in process(WIP)

Accountspayable

Finished goods




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Even if, the demand forecasting is pretty

accurate, it is often seen that material

procurement and production planning are

not seamles s ly l inked ( in sp i te o f

sophisticated Enterprise Resource Planning

systems) with future anticipated demand,

resulting in excess procurement of raw

materials or more work in process inventory.

Artificial sales

Companies listed on stock exchange are

under constant pressure to post better

results. Even companies which haveborrowed from banks face such pressures.

In some cases, these pressures could be

perceived, not the real ones.

Under such a scenario, managers have a

tendency to ‘pressurise’ channel partners to

lift off the finished goods even if there is no

real demand. Sometimes, channel partners

may themselves lift the goods if they have

incentives linked to sales volume but not to

collections from the customers.

By booking ‘artificial’ sales, managers are

able to show higher sales and profit for their

c o m p any . Ho we ve r , t h ey en d up

deteriorating the cash situation. This may

not be a big problem in good times but when

the going gets tough, huge cash is stuck in

the stocks in name of receivables fromchannel partners.

Loose control on receivables

Companies lag behind in monitoring and

following up their receivables. Sometimes,

sales staff shy away from following up for

overdue receivables. The hesitation is based on

a premise that the customers may run away to

the competitors. This hesitation is uncalled for.

Managers need to ask themselves- If there is a

delay in delivering products to a customer, will

she hesitate to call and ask for delivery? Then,

why should one hesitate to follow-up for a

delay in payment?

In many companies, there are delays in

sending invoice and related documents to

customers. This type of slippage can be used as

an excuse for delay in payment by customers.

It is also not uncommon to find customers

holding payments because supplier has not

re so l ved t he i r comp l a i n t . Manage rs

procrastinate to settle the claims to avoid a

charge to the P&L account, as a result of either

return of goods or a compensation to the

customer, because it may reflect in their

performance measurement. Customer enjoy

the bene f i t s o f th i s p rocras t inat i on ,

sometimes, even avoiding payment of those

bills which have no relationship with the bills

under dispute.



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Ineffective credit policy

When a company intends to sell its products

on credit, it determines credit limits for

customers based on likely sales to the

prospective customer, expected credit period

and customer’s risk profile.

Credit limits are, however, rarely reviewed

on a periodic basis. Initial credit limits may

become inappropriate after reviewing

customer’s buying and payment behaviour

over a period e. g., the customer may not

buy the goods as thought initially. Similarly,

some customers may not be making

payments as agreed but may still be

receiving goods based on initially set credit

limits.

It is also seen that initial credit limits are not

changed in the hope of customer placing a

bigger order in future. All this adds up to

giving more credit to risky customers who

may take it for granted.

Over enthusiasm

G e n e r a l l y , c u s t o m p r o d u c t s a r e

manufactured based on confirmed orders

but, sometimes managers initiate material

procurement and other planning activities

without actually receiving the confirmed

order. In such a case, if the customer

changes her mind, either canceling the order

or changing the specifications, these goodswill end up as non-moving inventory.

A machine tools manufacturer developed and

manufactured final product without receiving

complete specifications from a large customer.

As the business environment changed

drastically during this period, customer began

using variation in specifications as a delaying

tactic to take deliveries. This created cash flow

problems for the company putting the entire

business into jeopardy.

Even worse is that such custom products are

kept in stock in hope of an order for a similar

product in future. However, this may nothappen for months or sometimes years as seen

during our work with a consumer durables

company. Not many managers are willing to

take a bold decision to dispose of such items

because of non-realisation of full value, even if,

they are aware that the situation would not

improve by their indecision.

Lack of clarity in communication

Order management is a cross functional activity

which requires effective coordination of various

departments to deliver right product to the

customer on right time. Given the complexity

o f t oday ’ s bus i ness ope ra t i ons and

geographically dispersed teams, customer

requirements may not be communicated well to

planning and production departments, leading

to wrong procurement of materials or mistakes

in final products which customers refuse toaccept.

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The road to recovering cash

Once the root cause analysis is done to

uncover real reasons behind the requirement

for extra cash, the next step is to find ways

to free up cash from operations.

The road to recovering cash is long and

arduous but a systematic approach,

consistent efforts, and right performance

metrics can make all the difference.

Improve demand forecastingForecasting is not a perfect science but its

accuracy can be improved over a period of

time. It is possible to first start with a basic

model based on historic sales and inputs

from frontline sales staff. By accounting for

various factors, which can impact demand,

in the forecast model, a demand plan with a

confidence level of 85% to 90% can be

generated.

Rolling forecasts can further improve the

predictive accuracy of forecasting model.

Marketing team can develop demand

forecasts on a monthly basis, providing

estimated product-wise sales in quantity for

the following month and probable sales for

next two months. The numbers can then be

revised every month as better market

information becomes available.

Where the number of SKUs is very large and

the demand is not uniform across SKUs, it

makes more sense to engage in SKU level

forecasting. Though it may be a very

cumbersome and time taking exercise, it is

worth the effort. Moreover, with the

avai lab i l i ty o f today ’s In format ion

technology, the process can be made much

simpler and faster.

Demand forecasting should form the basis

for production planning and material

procurement plan. This would help in

achieving lower level of inventory and

thereby, avoiding unnecessary stocks. Thewhole process will bring more accountability

in all departments concerned with order

management.

Keep a tab on receivables

Receivables can hold a lot of cash, if left

unnoticed. To remind customers, managers

can send reminders to them a week before

the due date. Further, continuous follow-up

needs to be done, if the bill is not paid on

due date.

A segmented approach to receivables can

throw lot of insights. Receivables can be

classified as- bills not yet overdue, overdue

and non-moving. The criteria for classifying

a receivable as non-moving can be decided

based on credit term and nature of industry.

e.g. any receivables overdue over three orsix months can be considered as non-moving

receivables.



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to develop and implement a robust credit

policy. Credit manager can assess credibility

of prospective customer, expected sales

value, credit terms and the risk which the

company may be willing to take.

Credit policy should require strict adherence

to the credit limits while despatching goods.

It needs to have a built-in system to review

credit limit while booking orders. If the

credit limit is likely to exhaust with new

order, it should be communicated to the

customer to either receive the paymentbefore delivery or to at least take an

assurance that payment will be made on

delivery.

Credit policy should also have a provision for

any overdue outstanding bill. Such cases

should be treated as if credit limit is not

available, and no despatches should be

made until overdue outstanding is paid by

the customers.

Deciding credit limit should not be a one-

time affair. The limits should be reviewed at

least twice a year even in the normal course.

However, if there are continuous defaults by

customers, the limits should be reviewed

and revised without waiting for the periodical

review. The review should take into account

sales history and payments.

Next, a detailed analysis of each non-moving

receivable should be done along with the

account manager. If there is a dispute for

any receivable, managers should resolve it

quickly to convert the outstanding into cash.

When receivables are difficult to recover, it

may be possible to recover the goods from

the customer if the goods are in perfect

condition. Taking back the goods will result

in reversal of sales and profit booked earlier

but it is better than not recovering at all.

The company may have to sell such returneditems at a discount if the goods are sensitive

to change in seasons (either climatic or

festive seasons). Even then, it makes more

sense to convert such receivable into cash

rather than keep it as an irrecoverable

amount.

Finally, if the overdue outstanding is very

high and if it looks impossible to recover the

amount in ordinary course of business,

managers may have to recover through legal

means. This action may also help in sending

out a message to other customers who may

require a similar approach. Of course, taking

legal recourse should be the last option after

weighing value of customer in the long run,

costs of litigation and the value recoverable.

Develop a robust credit policyPrevention is always better than cure. For

supplying goods on credit, companies need




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Keep a dynamic inventory clearance

plan

Like receivables, it is also important to

adopt a segmented approach towards

inventory. All inventory including raw

materials, work-in-process1 and finished

goods should be classified as moving or non-

moving based on nature of industry, type of

process, the item and its value. As a first

step, consider any item, not moved for more

than six months as non-moving.

Next, check non-moving items for physicalavailability and the quantities available.

Based on this, the management can consider

various options to convert non-moving

stocks into cash.

Segmenting inventory into moving and non-

moving items needs to become a regular

feature of any reporting system about

inventory but it should go beyond reporting

to real action to improve cash situation.

A company known to us prepared a list of

over 500 swatches of various coloured yarns

while identifying non-moving items. Then,

management looked for options to dispose of

the stocks. Some options considered were to

sell non-moving stocks at substantial

discounts or to make use of the items for

some final products which could be saleable.

Finally, they chose the option best suited to

meet their specific situation.

If non-moving finished goods include some

unsaleable items like water heater or small

boilers, then management may have to take

a decision to dismantle the system, make

use of parts wherever possible and sell the

remaining as scrap because there will be no

gain by keeping the items in stock. (Please

see the box on page 9 to know whathappens when a bold decision is not taken).

When a company receives orders for export,

it is unlikely to make all products as per the

standard requirements. Invariably, some

export leftovers remain, which need to be

disposed of in the local market. If the

leftovers are not the standard items sold in

the local market, they may command far

less price than the export price or a

comparable price. Managers should accept

the fact and make a decision to dispose of

such items at the earliest instead of waiting

for a particular price2. This can make more

sense instead of allowing leftovers as non-

moving inventory, tying up cash.

1 Logically there should not be any non-moving work in process; but there are possibilities of such itemsif a custom product is produced without understanding or receiving complete specifications, leaving the

work-in-process item unsuitable for the customer

2 There was a time when polyester textured 100 denier product was not a standard product sold in

Indonesia and export leftovers could be sold far below the export price.



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When a company has to dispose of non-

moving stocks, it is unlikely to realise the

cost at which stocks are valued in the books.

This would invariably result in making losses

on account of disposal. However, managers

should not shy away from taking bold

decisions to dispose of at best possible

prices to convert dead inventory into hard

cash. Otherwise, the value of such items

would further decrease, putting an additional

burden on company’s profitability as well as

cash.

Eliminate communication gaps

Order management process should have a

well defined communication system to pass

information along the chain. Enterprise

Resource Planning (ERP) systems can do this

job quite well but in case of custom

products , there is a need to take extra care.

A slight deviation in customer’s requirement

can make product unsuitable for the

required application.

One way to deal with this is to hold a

meeting with production, planning and

purchase departments whenever a custom

order is received. In case, the number of

orders are more, meeting can be called on a

regular interval. If there is any confusion,

concerned department or person should

escalate the problem fast to stop producingany wrong product.

Align performance metrics with

company goals

When cash is made part of a company’s

performance indicators along with sales and

profitability, it should also reflect in

managers ’ KP Is (Key Per fo rmance

Indicators).

Sales team, for example, should be

measured not only on achievement of sales

targets but also on collections from the

customers. Similarly, production manager

should have inventory turn as a KPI alongwith production, machine utilisation and on-

time delivery.

There is a need to manage working capital

more efficiently in times good or bad, in

order to free up hard cash tied up in

inventory and receivables.

The steps to release cash are not one time

fixes and should be followed on a continuous

basis. By adopting a systematic approach,

exercising more discipline and providing

right incentives, managers can free up extra

cash and reduce their working capital

requirements.

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About KanvicKanvic is a management consulting firm helping businesses winning

strategies, develop drive profitable growth and achieve operational

excellence to reap long lasting rewards in fast growing Indian economy. We

work with C-level executives to develop innovative solutions for business

challenges of 21st century India by bringing in leading edge management

thinking informed by in-depth research and sound analysis.

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