Turning over the cash in your business again and again is like getting a big wheel to spin
In fact we call it the Working Capital Wheel. And the faster it spins, the less money you actually need to run your business. Why? Because we use the same money again and again and again. Faster and faster, working the money to make your business work, spinning smoothly and effortlessly. But it doesn't spin quickly and easily without an effort.
The effort is necessary because there are three cogs inside the wheel
Each cog can cause the wheel to spin faster, or to brake the wheel, slowing it down. And the slower the wheel spins the more cash it ties up. The three cogs are known as WIP (Work in Progress), Stock and Debtors. You can see them here:
When machinery gets dirty and clogged up it doesn't work as well. If the cogs get clogged they don't mesh as well. If they don't mesh well they don't work as efficiently as they should. They labour to do their job in turning the wheel.
Let's look at Work in Progress.
You typically have Work in Progress when you service clients (accountants and lawyers) or manufacture or service products. It may involve buying in parts and/or raw materials which are transformed into a product, or replacement parts for equipment being serviced. In either case you or your people will undoubtedly be spending some time working on the job.
What happens when the job is held up because some parts or materials that are required are not available when you need them? You still have the investment you've made in wages and the materials and parts you have used but you can't convert them to sales until the missing stuff arrives. Or the job is taking longer than it should for whatever reason.
So WIP becomes a dirty cog and it is not doing its job towards making the Working Capital Wheel spin faster. You need to unclog the cogs so it can do its job.
There are a number of steps you can take to unclog the WIP cog. They range from ensuring you have reliable suppliers, properly planning and scheduling jobs, to training your people so that they know how to do their jobs properly. Process improvement can help reduce the number of steps required to do a job. In short, before you can clean the WIP cog you have to know where the dirt is. What and where is slowing it down, taking more days than necessary to complete the job. Get the time down, rotate the WIP more rapidly, and use less cash in the process!
WIP is but one cog! Stock is another!
No doubt you've heard the term "dead stock", stock that just won't sell. It just sits on the shelf, gathering dust, a repository of tied up cash. Stock that has been long since paid for. But it doesn't have to be dead stock to make stock a dirty cog. Any stock that moves more slowly than it should do will do that.
The speed of stock movement will vary with the type of business, seasonality and a range of other factors. A lot of service and manufacturing businesses turn over their stock on average about once a month, a stock turn of 12. If you don't identify those slow moving items it may slip to say, 10 times. Is this a problem?
Let's look at whether it causes a problem for you in a very simplified example. If you were turning over for example $1,200,000 with a stock turn of 12 then you would need $100,000 of stock on average. Note I haven't worried about margins in this example. If stock turn slipped to 10 times then you would need $120,000 in stock to achieve the same level of sales.
You need to identify which items are clogging up the system and do something about them. And don't forget to look at how you re-order in the future.
And then there is the dreaded debtors cog!
Now debtors are the trap that most people fear more than any other dirty cog. Slowness in recovering debts can tie up large sums of cash. And the slower you are to collect your debts the harder it is to collect them. Would you like an example?
This client's terms of trade are 30 days, which means the average days it takes to collect his debts is 42. Now this client allowed his debt collecting to become untidy, the average days to collect the money drifted to 57 days. The result? At his level of business his overdraft grew by $70,000. He had to borrow from the bank to cover the cash he would otherwise have had if he had collected his debts in a timely fashion. Could that happen to you? Are there alternative ways around this problem?
There are a whole range of alternatives for you to consider, from good debtor policies and procedures to encouraging clients to carry the debt themselves through their credit card.
Unclog up your debtor cog and you will have more cash to play with.
Spinning wheels, turn turn turn!
Each of the cogs needs to turn easily and well if you are to make the best use of working capital in your business. The cogs turn faster, the wheel spins faster, you free up cash The better they work the more sales, and the more profits you'll achieve for the same investment. Improve your Return on Investment.
So for your next step!
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Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?