THE MOST IMPORTANT RESOURCE YOUR COMPANY HAS: CASH
By Doug Howardell, CPIM, PMP
the resources you should maximize, cash is the most important. More
businesses fail for want of cash than for want of profit.
Cash flows in a cycle into, around, and out of a business. Cash goes
out for facilities, equipment, labor and materials before cash comes
in as sales. That upfront expenditure of cash is usually called working
capital. You have a limited amount of working capital. Spend your
cash on buildings and maintenance, and there is less to spend on labor.
Spend it on material, and you have less to spend on equipment. In
good times, you can increase your line of credit to increase your
working capital and invest in all aspects of your business. These
are not good times.
Buildings and capital equipment are fixed costs, and fixed costs are
not easy to flex when business is down. Labor and material on the
other hand are variable costs which are more flexible. Most companies
do not have an excess of labor. People, unfortunately, are the first
to go when the going gets tough. Many companies however do have excess
material. Reducing inventory frees up cash, reducing the need to borrow
while leaving your critical people in place. Reducing inventory levels
relative to sales is the best and least painful way to increase available
The biggest opportunity for inventory reduction in most companies
is to reduce excess inventory. These are parts for which there are
future requirements but the balances on-hand exceed the current need.
This is different than obsolete inventory which are parts for which
there are no future requirements and no recent usage. Reducing excess
inventory is not only the biggest but also the best opportunity for
freeing up working capital. This is true for several reasons:
1. Reducing excess inventories reduces inventory dollars on the balance
sheet; so turns, return on assets and all of the financial ratios
improve. But unlike scrapping obsolete inventories, there is no negative
financial impact from inventory write-offs.
2. Reducing excess inventories improves cash flow by deferring incoming
purchases until the excess inventory is consumed and replenishment
is actually needed. Generally, there is a dollar-for-dollar improvement
in cash flow from reducing excess inventories.
3. The less excess inventories we have today, the less likely we are
to have obsolete inventories tomorrow.
A tool called Inventory Quality Ratio (www.IQR.com)
has proven excellent in identifying excess inventories and prioritizing
specific part numbers for reduction activities for hundreds of companies
in dozens of industries. Whatever tools you use to do so, identifying
and eliminating excess inventory is the quickest and best way to maximize
the cash flow and free up working capital.
information on freeing up working capital, improving cash flow and
reducing inventory, contact Doug Howardell,