You have got cash!

Know how to free it up

 You have got cash! Know how to free it up.

You have got cash! Know how to free it up.

Managers are aware that extra cash may be tied up in inventory

and receivables; yet they are not able to free it up. By adopting a
systematic approach, exercising more discipline and providing
right incentives, they can free up extra cash and reduce their
working capital requirements.

by Ravindra Beleyur

Sales become more important in a growing
economy than managing cash well. As a
result, many businesses need more cash
than required to run their operations. It is
easy to get more credit in good times but
securing more working capital during an
economic crisis is not as easy. No doubt,
the situation has improved but banks and
other financial institutions still need to
loosen their purse strings.
The recent financial crisis has made
businesses introspect and take drastic
actions to keep the wheels rolling.
Managers have learnt that cash is king
during recession. However, cash always
needs to be managed well- in times good
and bad.
It is not uncommon to hear that cash is
locked up in inventory and account
receivables (Exhibit 1). But, without looking
for ‘cash sinks’ in their business, managers
try to make up for the shortfall by
additional finance from banks or other
sources. Many a times, they also end up
delaying payments to the suppliers.
This article presents the reasons why
businesses find themselves in cash crunch
situations and what steps they can take to
improve such a situation.

Ravindra Beleyur (ravi@kanvic.com) is cofounder and a partner at Kanvic where he leads corporate
finance practice.

2

Exhibit 1 Where is your cash?
Accounts
receivable
Cash Inventory
Accounts
payable
Looking for cash culprits
Getting to the root of the problem is an
important first step towards improving cash
situation. Lack of discipline, wrong
performance metrics, system gaps and even
a tendency to avoid bold decisions can lead
to more cash tied up in inventory and
receivables. We look at some common cash
culprits in the following pages:
Gaps in demand forecasting
Effective demand forecasting plays an
important role in better inventory
management. While stock-outs have a risk
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Raw material
Work in process
(WIP)
Finished goods
of losing sales, excess stocks build up
inventory blocking cash in turn. There are
many instances when demand forecasting is
done at product line level but gaps emerge
at product level or SKU (Stock Keeping Unit)
level. This becomes more pronounced in
case of products which have a very long
manufacturing cycle time.
For new products, managers struggle to find
right benchmarks to forecast demand. This,
coupled with their overoptimism with new
product, results in excess stocks in many
cases.
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 You have got cash! Know how to free it up.
Even if, the demand forecasting is pretty
accurate, it is often seen that material
procurement and production planning are
not seamlessly linked (in spite of
sophisticated Enterprise Resource Planning
systems) with future anticipated demand,
resulting in excess procurement of raw
materials or more work in process inventory.
Artificial sales
Companies listed on stock exchange are
under constant pressure to post better
results. Even companies which have
borrowed from banks face such pressures.
In some cases, these pressures could be
perceived, not the real ones.
Under such a scenario, managers have a
tendency to ‘pressurise’ channel partners to
lift off the finished goods even if there is no
real demand. Sometimes, channel partners
may themselves lift the goods if they have
incentives linked to sales volume but not to
collections from the customers.
By booking ‘artificial’ sales, managers are
able to show higher sales and profit for their
c o m p a n y . H o w e v e r, t h e y e n d u p
deteriorating the cash situation. This may
not be a big problem in good times but when
the going gets tough, huge cash is stuck in
the stocks in name of receivables from
channel partners.
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Loose control on receivables
Companies lag behind in monitoring and
following up their receivables. Sometimes,
sales staff shy away from following up for
overdue receivables. The hesitation is based on
a premise that the customers may run away to
the competitors. This hesitation is uncalled for.
Managers need to ask themselves- If there is a
delay in delivering products to a customer, will
she hesitate to call and ask for delivery? Then,
why should one hesitate to follow-up for a
delay in payment?
In many companies, there are delays in
sending invoice and related documents to
customers. This type of slippage can be used as
an excuse for delay in payment by customers.
It is also not uncommon to find customers
holding payments because supplier has not
resolved their complaint. Managers
procrastinate to settle the claims to avoid a
charge to the P&L account, as a result of either
return of goods or a compensation to the
customer, because it may reflect in their
performance measurement. Customer enjoy
the benefits of this procrastination,
sometimes, even avoiding payment of those
bills which have no relationship with the bills
under dispute.

Ineffective credit policy
When a company intends to sell its products
on credit, it determines credit limits for
customers based on likely sales to the
prospective customer, expected credit period
and customer’s risk profile.
Credit limits are, however, rarely reviewed
on a periodic basis. Initial credit limits may
become inappropriate after reviewing
customer’s buying and payment behaviour
over a period e. g., the customer may not
buy the goods as thought initially. Similarly,
some customers may not be making
payments as agreed but may still be
receiving goods based on initially set credit
limits.
It is also seen that initial credit limits are not
changed in the hope of customer placing a
bigger order in future. All this adds up to
giving more credit to risky customers who
may take it for granted.
Over enthusiasm
G e n e r a l l y, c u s t o m p r o d u c t s a r e
manufactured based on confirmed orders
but, sometimes managers initiate material
procurement and other planning activities
without actually receiving the confirmed
order. In such a case, if the customer
changes her mind, either canceling the order
or changing the specifications, these goods
will end up as non-moving inventory.
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A machine tools manufacturer developed and
manufactured final product without receiving
complete specifications from a large customer.
As the business environment changed
drastically during this period, customer began
using variation in specifications as a delaying
tactic to take deliveries. This created cash flow
problems for the company putting the entire
business into jeopardy.
Even worse is that such custom products are
kept in stock in hope of an order for a similar
product in future. However, this may not
happen for months or sometimes years as seen
during our work with a consumer durables
company. Not many managers are willing to
take a bold decision to dispose of such items
because of non-realisation of full value, even if,
they are aware that the situation would not
improve by their indecision.
Lack of clarity in communication
Order management is a cross functional activity
which requires effective coordination of various
departments to deliver right product to the
customer on right time. Given the complexity
of today’s business operations and
geographically dispersed teams, customer
requirements may not be communicated well to
planning and production departments, leading
to wrong procurement of materials or mistakes
in final products which customers refuse to
accept.
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You have got cash! Know how to free it up.
The road to recovering cash
Once the root cause analysis is done to
uncover real reasons behind the requirement
for extra cash, the next step is to find ways
to free up cash from operations.
The road to recovering cash is long and
ard uo us b ut a s y s t emat i c ap p roac h ,
consistent efforts, and right performance
metrics can make all the difference.
Improve demand forecasting
Forecasting is not a perfect science but its
accuracy can be improved over a period of
time. It is possible to first start with a basic
model based on historic sales and inputs
from frontline sales staff. By accounting for
various factors, which can impact demand,
in the forecast model, a demand plan with a
confidence level of 85% to 90% can be
generated.
Rolling forecasts can further improve the
predictive accuracy of forecasting model.
Marketing team can develop demand
forecasts on a monthly basis, providing
estimated product-wise sales in quantity for
the following month and probable sales for
next two months. The numbers can then be
revised every month as better market
information becomes available.
Where the number of SKUs is very large and
the demand is not uniform across SKUs, it
makes more sense to engage in SKU level
6
forecasting. Though it may be a very
cumbersome and time taking exercise, it is
worth the effort. Moreover, with the
availability of today’s Information
technology, the process can be made much
simpler and faster.
Demand forecasting should form the basis
for production planning and material
procurement plan. This would help in
achieving lower level of inventory and
thereby, avoiding unnecessary stocks. The
whole process will bring more accountability
in all departments concerned with order
management.
Keep a tab on receivables
Receivables can hold a lot of cash, if left
unnoticed. To remind customers, managers
can send reminders to them a week before
the due date. Further, continuous follow-up
needs to be done, if the bill is not paid on
due date.
A segmented approach to receivables can
throw lot of insights. Receivables can be
classified as- bills not yet overdue, overdue
and non-moving. The criteria for classifying
a receivable as non-moving can be decided
based on credit term and nature of industry.
e.g. any receivables overdue over three or
six months can be considered as non-moving
receivables.

Next, a detailed analysis of each non-moving
receivable should be done along with the
account manager. If there is a dispute for
any receivable, managers should resolve it
quickly to convert the outstanding into cash.
When receivables are difficult to recover, it
may be possible to recover the goods from
the customer if the goods are in perfect
condition. Taking back the goods will result
in reversal of sales and profit booked earlier
but it is better than not recovering at all.
The company may have to sell such returned
items at a discount if the goods are sensitive
to change in seasons (either climatic or
festive seasons). Even then, it makes more
sense to convert such receivable into cash
rather than keep it as an irrecoverable
amount.
Finally, if the overdue outstanding is very
high and if it looks impossible to recover the
amount in ordinary course of business,
managers may have to recover through legal
means. This action may also help in sending
out a message to other customers who may
require a similar approach. Of course, taking
legal recourse should be the last option after
weighing value of customer in the long run,
costs of litigation and the value recoverable.
Develop a robust credit policy
Prevention is always better than cure. For
supplying goods on credit, companies need
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to develop and implement a robust credit
policy. Credit manager can assess credibility
of prospective customer, expected sales
value, credit terms and the risk which the
company may be willing to take.
Credit policy should require strict adherence
to the credit limits while despatching goods.
It needs to have a built-in system to review
credit limit while booking orders. If the
credit limit is likely to exhaust with new
order, it should be communicated to the
customer to either receive the payment
before delivery or to at least take an
assurance that payment will be made on
delivery.
Credit policy should also have a provision for
any overdue outstanding bill. Such cases
should be treated as if credit limit is not
available, and no despatches should be
made until overdue outstanding is paid by
the customers.
Deciding credit limit should not be a one-
time affair. The limits should be reviewed at
least twice a year even in the normal course.
However, if there are continuous defaults by
customers, the limits should be reviewed
and revised without waiting for the periodical
review. The review should take into account
sales history and payments.
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 You have got cash! Know how to free it up.

Keep a dynamic inventory clearance
plan
Like receivables, it is also important to
adopt a segmented approach towards
inventory. All inventory including raw
materials, work-in-process1 and finished
goods should be classified as moving or non-
moving based on nature of industry, type of
process, the item and its value. As a first
step, consider any item, not moved for more
than six months as non-moving.
Next, check non-moving items for physical
availability and the quantities available.
Based on this, the management can consider
various options to convert non-moving
stocks into cash.
Segmenting inventory into moving and non-
moving items needs to become a regular
feature of any reporting system about
inventory but it should go beyond reporting
to real action to improve cash situation.
A company known to us prepared a list of
over 500 swatches of various coloured yarns
while identifying non-moving items. Then,
management looked for options to dispose of
the stocks. Some options considered were to
sell non-moving stocks at substantial
discounts or to make use of the items for
some final products which could be saleable.
Finally, they chose the option best suited to
meet their specific situation.
If non-moving finished goods include some
unsaleable items like water heater or small
boilers, then management may have to take
a decision to dismantle the system, make
use of parts wherever possible and sell the
remaining as scrap because there will be no
gain by keeping the items in stock. (Please
see the box on page 9 to know what
happens when a bold decision is not taken).
When a company receives orders for export,
it is unlikely to make all products as per the
standard requirements. Invariably, some
export leftovers remain, which need to be
disposed of in the local market. If the
leftovers are not the standard items sold in
the local market, they may command far
less price than the export price or a
comparable price. Managers should accept
the fact and make a decision to dispose of
such items at the earliest instead of waiting
for a particular price2. This can make more
sense instead of allowing leftovers as non-
moving inventory, tying up cash.

1
Logically there should not be any non-moving work in process; but there are possibilities of such items
if a custom product is produced without understanding or receiving complete specifications, leaving the
work-in-process item unsuitable for the customer

2
 There was a time when polyester textured 100 denier product was not a standard product sold in
Indonesia and export leftovers could be sold far below the export price.

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Managers don’t dare dispose of

non-moving stocks!

During my work in South Asia, I was responsible for the revival of a

weaving unit in addition to P&L responsibility of a polyester textured
yarn manufacturing company.

The group had a polypropylene continuous filament yarn SBU which

had 20 ton non-moving coloured yarns. This yarn could have been
used by the weaving unit to manufacture stock lot items for readily
available market at stock lot prices with a decent margin if the yarn
company could sell to the weaving company at cost plus a small
margin but below market price.

The yarn SBU head was unbending in realising the market price
without even thinking how much value had already been lost in
keeping the inventory. Moreover, the group as a whole would have
made a gain of $25,000. (It was a time when the bank interest rate
had exceeded 18% per annum).

Despite a clear gain to the group, yarn SBU head did not reduce the
price and sell yarn to the weaving unit. I am sure that yarn could be
lying there even today virtually worth nothing!

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 You have got cash! Know how to free it up.
When a company has to dispose of non-
moving stocks, it is unlikely to realise the
cost at which stocks are valued in the books.
This would invariably result in making losses
on account of disposal. However, managers
should not shy away from taking bold
decisions to dispose of at best possible
prices to convert dead inventory into hard
cash. Otherwise, the value of such items
would further decrease, putting an additional
burden on company’s profitability as well as
cash.
Eliminate communication gaps
Order management process should have a
well defined communication system to pass
information along the chain. Enterprise
Resource Planning (ERP) systems can do this
job quite well but in case of custom
products , there is a need to take extra care.
A slight deviation in customer’s requirement
can make product unsuitable for the
required application.
One way to deal with this is to hold a
meeting with production, planning and
purchase departments whenever a custom
order is received. In case, the number of
orders are more, meeting can be called on a
regular interval. If there is any confusion,
concerned department or person should
escalate the problem fast to stop producing
any wrong product.
10
Align performance metrics with
company goals
When cash is made part of a company’s
performance indicators along with sales and
profitability, it should also reflect in
managers’ KPIs (Key Performance
Indicators).
Sales team, for example, should be
measured not only on achievement of sales
targets but also on collections from the
customers. Similarly, production manager
should have inventory turn as a KPI along
with production, machine utilisation and on-
time delivery.
There is a need to manage working capital
more efficiently in times good or bad, in
order to free up hard cash tied up in
inventory and receivables.
The steps to release cash are not one time
fixes and should be followed on a continuous
basis. By adopting a systematic approach,
exercising more discipline and providing
right incentives, managers can free up extra
cash and reduce their working capital
requirements.
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About Kanvic
K anvic is a management consulting firm helping businesses winning
strategies, develop drive profitable growth and achieve operational
excellence to reap long lasting rewards in fast growing Indian economy. We
work with C-level executives to develop innovative solutions for business
challenges of 21st century India by bringing in leading edge management
thinking informed by in-depth research and sound analysis.

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