Beware of Complacency in Strong Economic Times
Unless your leadership has a disciplined program of continuous improvement in place with timely monitoring of the key performance indicators (KPI’s) and a process of corrective action when the company veers off track you will not maximize the improved profitability of these strong economic times. In simple terms a strong economy can create complacency within the management team.
A simple example is the concept of Cash Cycle. In a manufacturing company the steps in the Cash Cycle are as follows:
- You start with cash
- You purchase some material
- You add labor and overhead to the material to create a finished product (inventory)
- You sell that inventory which creates a receivable
- You collect the receivable
- You end up with cash
The definition of Cash Cycle is you start with cash and you end with cash – how long is that cycle time in days? The formula is Inventory Days plus Receivable Days less Payable Days. The concept is when in the Inventory and Receivable phases you have capital tied up. The Payable phase is the time period that your vendor is financing your purchase of material. The shorter the total Cash Cycle the less time that you have capital tied up and costing you money in terms of financing. The financial impact in dollars of course is dependent on the volume of business you are doing. Below is an example of how lack of focus can cost your organization profit opportunities.
Days in Receivable: A slow increase in the number of days that it takes to collect our receivables from 32 days in January 2017 to 40 days in September 2018. Are we monitoring past due receivables and making the follow up calls in terms of collections?
Days in Inventory: A slow increase in the number of days tied up in inventory from 34 days in January 2017 to 44 days in September 2018. Are we bringing in larger quantities of material without being able to put it into production due to equipment capacity constraints or labor availability and/or productivity?
Days in Payables: A slow decrease in the number of days in payables from 32 days in January 2017 to 27 days in September 2018. Why are we paying our vendors faster? This should only be happening if there is a financial benefit such as an early pay discount.
Cash Cycle Days: In this example our cash cycle time has increased from 34 days in January 2017 to 57 days in September 2018. Our budget was to improve from 50 days in December 2017 to 43 days by the end of 2018. We have lost sight of the budgeted metrics that we put in place at the start of the year that were a critical component to accomplishing our overall objectives. How do we get back on track?
All of these are examples of internal metrics that need to be monitored and managed for the company and involve multiple functional areas including purchasing, manufacturing, accounting, and sales. To take this a step further set goals for continuous improvement in these metrics. When you meet the goal – reset the goal for further improvement. This will establish a culture of continuous improvement in your organization – keep in mind “if your organization is not continually improving, you are losing ground to your competition”.
At CDH our Executive Focus service offering is all about making your individual internal metrics come alive. For over 40 years we have been helping companies monitor and manage their KPI’s in a unique format to drive continuous improvement. If you would like to learn more about our Executive Focus process, please contact Dennis Pierce, Director of Management Consulting at [email protected] or 262.784.4040.