Editor’s Note: Today’s blog is from Ty Kiisel who shows us how you can be affected by your supply chain finances.
Every business, including manufacturing operations, rely on cash flow to meet important needs like fueling growth and keeping the manufacturing process rolling forward. Unfortunately, it’s possible for a growing, healthy-looking business to be cash poor. This can be disastrous for manufacturers that need to purchase raw materials to produce their products. No raw materials equals no manufactured goods equals no profits.
Every business needs working capital to function, but it’s not as simple as determining whether or not you have cash in the bank at the end of the month. Your accountant will tell you that working capital is your Current Assets minus your Current Liabilities. To fully understand the formula, Current Assets include the cash you have in the bank, your current Accounts Receivable and your inventory. Your Current Liabilities can include your current Accounts Payable and any long-term payables (think small business loans, lines of credit, etc.) your business may have. Your accountant can help you determine what to include in your list of assets and liabilities.
If you divide the value of your Current Liabilities into your Current Assets, you’ll come up with a ratio of assets to liabilities. This is an important formula to have a handle on to avoid negatively impacting your supply chain finances. The goal should be to shoot for a ratio of twice as many assets as liabilities (or a 2:1 ratio), but anything below 1:1 should be a red flag that you have negative working capital and the result will likely be a negative impact on your supply chain finances.
Supply Chain Finances Can Be a Root Cause of Your Problems
RT Custer, the owner and co-founder of Vortic Watch Company, describes the challenge of managing his supply chain this way:
“To keep my cost of goods at a manageable level, I need to order hundreds of parts. I’m then restoring hundreds of components of the watches, which is very, very slow. The lead times for all my components are very long. Managing my whole supply chain is complicated and the root cause of my cash flow challenges.”
For Custer to successfully manage his working capital needs to accommodate his longer lead times (which can be six to nine months), in addition to his manufacturing processes, he has to pay close attention to his new product development plans and how he manages his inventory of raw materials. As a result, he’s often developing new products while the current products are in production.
“We’ve had so many ideas on how to make the process and products better that sometimes when the new idea gets implemented, and you start making money from it, it’s almost six to nine months later,” he says. “We sold Version 1 of our product for almost 18 months, even though we started developing Version 2 within our first six months. It took us over a year to develop.”
This is something many manufacturers face, but can be a big challenge for smaller manufacturers because it directly impacts their cash flow and their supply chain requirements.
Proactively Attacking Potential Cash Flow Challenges
The next step is to take action to minimize and mitigate the impact a cash crunch can have on your supply chain. Here are a few short- and long-term solutions you might consider:
- Negotiate terms with your suppliers. As a good customer, if you are current with your suppliers, you are likely in the driver’s seat when negotiating. Extending 30-day terms to 60 or 90 days might be a more preferable option for them when compared to the risk of losing your business altogether to someone else who will. And it might make all the difference when managing your cash flow.
- Offer prompt payment discount terms to your customers. To encourage your customers to pay their invoices today rather than wait, you can offer a discount to those customers who pay on receipt or within 10 days. Although you might not be able to get all of your customers to take advantage of the discount, there will be those that do—which can help your cash flow.
- Look into factoring. Factoring your accounts receivable is a popular way for manufacturers in the textile industry (for example) to mitigate cash flow gaps. What’s more, there are several factors that have put the process entirely online, making it easier for companies to factor their invoices—and easier for their customers, too.
- Consider a small business loan. Short-term loan options available online generally make it simple to apply, offer a quick response, and have the money in your account very quickly—sometimes within a couple of days. You might also consider a line of credit to help minimize the impact of temporary cash flow gaps.
Don’t forget, it’s important to consider the impact these techniques could have on your Working Capital Ratio. Anytime you borrow, whether it’s payment terms or a small business loan, it should be folded into your ratio. This is something else your accountant can help you with. However, if you can get your customers who pay by invoice to pay early, it can positively impact that ratio.
Many small business owners aren’t excited about the accounting process, but having an understanding of working capital, cash flow, and the impact it can have on your supply chain can make the difference between a highly successful business and one that struggles. Fortunately, there are resources (like full- and part-time accounting professionals) to help you successfully manage your cash flow and build a thriving business.
Ty Kiisel is a contributing author focusing on small business financing at OnDeck, a technology company solving small business’s biggest challenge: access to capital. With over 25 years of experience in the trenches of small business, Ty shares personal experiences and valuable tips to help small business owners become more financially responsible. OnDeck can also be found on Facebook and Twitter.