Over the past couple of weeks I've been sharing how vital it is to know and understand all the key numbers in your business, and how to know which numbers are most critical to your business.
I want to continue that theme today by discussing the 5 key levers of operating cash flow. Building operating cash flow is non-negotiable for a thriving business. This is what knowing the numbers is all about. If you don’t know these figures in your business there is no way you can make informed decisions.
Operating cash flow is the ability of the business to convert profits into cash. This is what we usually simply call profit.
Operating cash flow is needed to surge into the future and execute on the plan. Without free operating cash flow you won’t get into the future. You’re constantly fighting the battle of now, of having just enough cash in the bank. You must always be growing money in the bank and growing your operating cash flow.
This is all part of productivity. The five key levers for operating cash flow are:
1. Sell more
2. Spend less – as a percentage of revenue
3. Ensure that accounts receivable days are decreasing – getting the dollars quicker
4. Reduce inventory days
5. Increase accounts payable days
Within those five levers – that’s all you get – are myriad strategies and themes for constant growth in becoming a benchmark business.
Let’s have a look at each of these levers.
1. Sell more
Selling more is fairly simple to understand. However, it’s so much more productive to sell within the target market you have chosen. Your most productive and value-creating work is for the target market you have chosen. That’s why you have to be so clear about your position. It’s about repeat business, because you know your delivery and solution for them is optimal, and it relates to people then bringing referral business. Your ability to bundle and to create options to sell more as the business grows builds recurring and long-term income.
The principal decision needs to be, who are you selling to?
What is the product and/or service that you need to be championing in your market place so that you are attracting more repeat and referral business? If you don’t know your position in the market with great clarity, this is not something you can achieve.
2. Spend less
This is the second lever. But, it’s not as simple as simply spending fewer dollars. It must be spending less as a percentage of sales. This is a fundamental aspect of business activity and analysis.
This is about common sizing, so that you can compare figures accurately. All expenses must be measured against sales as a percentage. All sales and cash out items are measured against sales, therefore you are measuring trends over time and they can be accurately compared. This allows you to work out where you are getting better or worse in your organisation, and to be in a position so you can press the right lever and make better decisions.
Converting every dollar amount to a percentage of sales helps you to be more productive with fewer resources, which leads to more profit. It’s about utilisation, and the relationship between the decision to invest and the sales outcomes.
How do you ensure you are running a business that is running lean, that you are not ‘pimping your ride’? You must constantly be reviewing cost-to-revenue. Something might cost you $200,000, but that’s not the important figure. What is that costing you as a percentage of revenue?
Spend less, but as a percentage of revenue, not as a dollar figure. If the dollar figure goes up, that’s okay if it drives a bigger increase in revenue. Nobody gets rich just by cutting expenses.
'NOG' - No overhead growth as a percentage of income
The great teachings and accountability of my mentor Keith J. Cunningham introduced me to the concept of ‘NOG’. What does this stand for? ‘No overhead growth’. So, what does this mean? It means… no pimping your ride.
For example, once you have established the figures for an office renovation, you must stick to them – no ifs, ands, or buts. You must come up with a plan that suits your needs and not deviate from this.
If you’re still in the early days of growing your training business, do you need $2,000 chairs in the training room from a high-end designer, or will Ikea chairs do the trick? Do you need a $3,000 coffee machine or will an $800 one do for now? It’s all about having a strategy and sticking to it. Five years from now you may be working with the top CEOs in the country – or the world.
Then you may need the designer furniture and coffee maker. But not now – so, no overhead growth as a percentage of income.
It’s horses for courses. The only thing you should be investing in is resources that help you produce more sales relative to the amount spent. This gives you a greater chance of more profit. Just get on with being productive.
3. Reduce accounts receivable days (debtors)
Your productivity can be boosted through much more efficient and effective terms of trade systems. It takes good people, strategies and systems to deliver that. This is about how you must have firm and clearly defined rules of the game. Your terms of trade conversation with your clients has to be very clear. You must set the expectations up front.
If your finance department needs to be more productive, you must provide a terms of trade platform that they can use. If you don’t have this structure your accounts department can’t follow a system. Your finance department must be okay making the hard phone calls and chasing debts. They can’t do this without good systems in place. I’ve seen this send businesses to the wall if not handled well.
To build a good working relationship with your debtors you – or somebody in your finance department – must call them frequently. You must build relationships with the person who pays the accounts. You must also stop dealing with people who don’t meet your terms or who are slow payers. If they are having problems, look for ways to work with them if they don’t have enough cash in the bank right now, such as paying by credit card or setting up a line of credit. But, if they are still giving you trouble, it’s time to cut them loose.
A client is only of value to you if they are putting money in the bank according to your plan and mutual agreement.
If you are loose with your systems, you spend time chasing money and then your team is not being productive. A great way to stay on top of your debtors is to have the ‘seven days in advance’ conversation.
The ‘seven days in advance’ conversation involves calling your clients seven days before an invoice is due. Say "we’re working out our budget to pay our bills – just checking that you will be able to pay."
If you do this every month, or when your debtors are due to pay, who do you think will be at the top of the list to get paid every month?
If payment is going to be an issue, wouldn’t you like to know about it beforehand? You’ve provided the product or service in exchange for an agreed amount. You’re not a bank (unless you are).
4. Reduce inventory days
How do you effectively sell your inventory in quicker time-frames? This is what this lever is all about. How do you move it quicker and more of it? Measure your inventory and understand your utilisation. You must understand the relationship between productivity and return on assets. Monitor your wastage for products and time, and monitor your shrinkage.
If you are going to get more productive here it’s in inventory. Even the people and time are inventory. It’s not difficult, it’s about discipline. It doesn’t happen overnight but you must be conscious about it. If you are a student of this you are going to get better at it.
Practise, practise, practise.
How can you make a better decision or repeat that good decision? How can you make the best, highest value use of the time in your calendar?
Your ability to turn inventory over quicker and use time more productively is key to your ability to get more profits quickly. If you are selling products or time you have to make sure you are turning over that time or product more regularly. This is called stock turn. Some people think this only applies to products but not services.
Think again. If you are selling a service you need to be more efficient and effective. When selling products, turning stock over more regularly is critical to long-term cash flow growth.
You must work to increase your stock turn. This applies to products or services. How do you do this? Understand the power of utilisation and assets and how many sales you get from your assets.
You must negotiate with your suppliers and tell them that your business is growing. You can then renegotiate your terms, and as your organisation purchases more from your suppliers you are in a better position for bargaining. You must take advantage of this.
You must also keep an eye on who else is out there, so that you know whether you are working with the best suppliers. Talk to new suppliers who are aggressive in seeking your business on your terms. If you have people or products who are not productive anymore on your terms you must move on. Turn this into cash and people who are going to be more productive.
5. Increase payable days
This is one of the easiest business strategies you will ever come across. It is as simple as paying your bills when they are due. Not a week before or a few days before. When they are due.
I see too many businesses that have no structure for the payment of their bills. They have an ‘in’ tray, and every few days somebody pulls out a pile of bills and pays some that are due anytime in the next week or so. But why would you do this? You want your money in your bank account – not your suppliers’ – for as long as you can. So, create systems within your business that ensure bills are paid on the day they are due.
You should also try to negotiate longer payment terms with suppliers; again, you’ll be in a stronger position to do this as your business grows. It’s important to build a rhythm in your business.
Paying once a month is ideal if you can agree these terms. From your budget perspective, if you confirm that with your suppliers and you meet this payment that’s great.
Here are a few things to keep in mind for your payments systems:
- If there is a discount for early payment, consider whether this bill is worth paying early.
- Make sure you pay on time. You must build a reputation for being a great payer. Do not stretch people or take advantage.
- Always communicate in advance if you will have a problem meeting a commitment. People will still be unhappy but they will appreciate the call.
- You can’t have a system that is robust in collecting but not paying. This is not the way to build a good reputation.
- Always avoid late charges.
- Be a firm negotiator with your suppliers but don’t be unreasonable. You must have good working relationships with your suppliers, and you won’t attract A-grade suppliers if you have unreasonable expectations.
Remember, first what and then how. If you’re clear about your plan and being structured, you know where you are going.
If you have a plan, a timeline and an agreement you will get where you are going. If you get the plan in place it becomes just about doing the work. Then these issues are not a distraction. If you have a culture where a supplier turns up unexpectedly and says ‘I have a pallet of paper today and you’ll get $7 off per 1,000 sheets if you buy now’, and you say, ‘Wow, that’s a good deal’, and you buy the pallet, was that a good decision?
Do you really need that pallet? That paper might last you four years, but the invoice is due in 30 days. That’s a bad decision. Don’t pay bills early. Pay them when they are due. You need a more productive terms of trade system to make sure you are paying suppliers when due. Not five days sooner or five days later.
This is a measurable number that ensures your dollars are in your account for as long as possible.
Each of these 5 levers is critical to growing your operating cash flow - which, in turn, is vital to growing your business and executing your plans into the future.
Once you master each of these 5 levers, you will be well on your way to becoming a benchmark business.
Power to you!
Founder, CEO - Business Benchmark Group
Stefan Kazakis on 5 May 2018
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