03 December 2008

Increasing Your Cash Velocity

Cash velocity is related to cash flow and in tough economic times, nothing -- and I mean nothing -- is more important to the health of a business than cash flow. Most organizations cannot survive if they run out of cash. In essence, an organization with a good cash flow is a healthy organization and an organization with a bad or declining cash flow is at risk.

The Cash Velocity value measures how rapidly your business generates cash. The Cash Velocity of your organization is a good one-stop metric on your business' health because it includes so many important factors.

Here is the way we would recommend that you calculate your Cash Velocity (CV):

CV = Throughput / Cash-to-Cash Cycle Time
  • Throughput = Revenues minus TVC (truly variable costs)
  • TVC or Truly Variable Costs are those costs that are directly proportional to your revenues and, in a manufacturing operation (for example), would typically include raw materials and outside processing costs, but would not include labor or overhead since labor and overhead do not vary directly with the number of units produced.
  • Cash-to-Cash Cycle Time is the average number of days it takes from the time you pay out cash to a vendor or supplier for raw materials or outside processing until you collect from your customer for a resulting finished good. The chart below shows how this cycle may be understood.

The Cash Velocity metric is, as a result, stated in terms of "Throughput-dollars per day."
As stated above, this consolidated metric is influenced by a number of factors upon which management may take action for improvement:
  1. Increasing Throughput - This may be done by either increasing revenues or reducing truly variable costs. Revenues may be increased in the aggregate (more sales) or by increasing prices (where the market will bear it and the net result will not actually be reduced aggregate revenues).
  2. Decreasing the Cash-to-Cash Cycle Time - This, too, may be addressed in multiple ways:

    a) Reducing Inventories will mean that goods will sit a shorter period of time in either raw materials, WIP, or finished goods inventories before they are shipped to your customers.

    b) Changing the terms of your sales (reducing the days between shipment and receipt of payment from your customers where the market will bear such a change).

    c) Accelerating collections (if you have a significant number of customers that delay payment beyond your terms).

    d) Shortening your manufacturing cycle time (if possible).
This metric may be further refined so that you are not evaluating your organization as a whole. Instead, you may look at Cash Velocity by product line, for instance, if there are significant differences in how your product lines behave. There is a big difference between a product line that produces $1 million in Throughput on a 300-day cash-to-cash cycle ($3,333 Throughput per day) and another product line that produces $800,000 in Throughput with a 90-day cash-to-cash cycle ($8,889 Throughput per day). Clearly, the latter is "healthier" for your business even though the total revenues may be lower.

Email me.

©2008 Richard D. Cushing

No comments: