Laurie Owen: Keep Rolling

AS A STORE-OWNER, it’s important for you to know style. It’s important for you to know prices. But the thing that it’s most important for you to know is cash-flow management, because while a few bad style picks or a couple of rotten buys won’t put you out of business, a single cash-flow management mistake can close your doors forever.

To start this lesson, take a good look at the picture of a little thing I call “The Working Capital Wheel” (above), which illustrates the major components of cash flow and shows how they interact. Done? Now, I’ll explain how the turning of the wheel affects you.

When looking at your “Working Capital Wheel,” you’ll need to answer two important questions:

1. How long from the time the dollar leaves the till until it comes back?
   
2. What do you do in the meantime?

The cycle goes like this: you invest your dollars in inventory. They sit there for a number of days (let’s say 295) until you sell the inventory on account. Many businesses now have to wait another 30-90 days to collect their accounts receivable. The catch, of course, is how do you operate while the dollar is sitting there in inventory and receivables?

The answer: you borrow. You borrow from the bank or you borrow from your suppliers. The bank calls this a loan, charges interest, and it becomes an expense that reduces profits. Your suppliers call this credit and they don’t charge interest — unless you don’t pay. On some merchandise, they give you extended credit and call it dating; however, when that date passes, look out — some hefty interest charges may await you. Either way, it doesn’t matter how good the terms are if the product doesn’t sell.

Each time the cycle is completed — cash to inventory to accounts receivable and back to cash — a little bit of net profit hopefully drops out the bottom. This is a verrrrry sensitive process, however, and, as the old rhyme says, there’s “many a slip `twixt the cup and the lip.”

What drives this wheel? As you can see from the diagram, it’s sales. As sales increase, the working capital wheel must either expand or turn faster. When it expands, you must put more money into inventory and receivables, or you must turn it a little faster.

Think of this in terms of the gear ratio on a bicycle. You have different ratios for different situations: uphill, downhill, racing, pleasure cruising. When you know what you want to do and what’s happening, you select the proper gear ratio. When conditions change and what you’re doing is no longer appropriate, you change. This can be a planned change that you control or it can be a reaction to symptoms — you can’t pedal any more and are about to tip over. Financially, we usually define this latter condition as a cash-flow shortage.

The basic skill (just as in bicycle riding) is maintaining your balance. If the wheel turns too slowly, inventory builds and cash flow dries up. This situation can occur even when sales are rising — if inventory is rising faster. If the wheel turns too fast, you experience “out-of-stocks” and lose sales. So ride carefully!

• BREAKOUT
• Ride Like a Pro

How you can best keep your balance when riding “The Working Capital Wheel”:

1. Prepare a 12-month cash-flow budget and update it monthly.

2. Know your cash balance on a weekly basis.

3. Establish a line of credit with your bank before you need it.

4. Use long-term financing to pay for equipment and store improvements.

5. Monitor cash-flow ratios (current and quick ratios, plus inventory, A/P and A/R turns) monthly.

6. Stay on good terms with your vendors to maintain good credit standing.

7. Get a third-party credit provider, collect old A/R and phase out accounts — get out of the banking business.

8. Inventory management — get rid of the dogs and don’t buy new ones.

9. Drive sales but not at the cost of increased credit or over-discounting.

10. Get an accurate P&L and a balance sheet by the 10th of each following month.

• MONEY MATH
• What’s Your Working Capital

The Formula

(Inventory Turns Days) + (Accounts Receivable Collection Days) – (Accounts Payable Days) = Days in Working Capital Cycle

Using the Formula

Drop in your Inventory Days numbers (divide 365 by your Inventory Turn number), your A/R collection days (divide 365 by your A/R turn number), and your Accounts Payable Days (divide 365 by your A/P turn number) to see how fast cash flows through your company.  Faster cycle = more cash. More cash = less interest and higher profits. How does your company stack up?

This story is from the November 2006 edition of INSTORE.