FinListics  Bizdom: Cashing in on Cash Operating Cycle

From our "Exploring a Metric" series--November 2008 FinListics Newsletter

provided to all FinListics registered users and clients for internal publishing and viewing

By Dr. Stephen G. Timme

It’s impossible today to avoid the news about failing or stressed credit institutions. The tumultuous events in the credit markets have now spilled over into the “real economy.” Retailers, distributors, manufacturers and many others are finding:

• the amount they can borrow is lower
• the rate they pay to borrow is higher

These facts make it more challenging for a company to maintain — much less grow — its business.

Due to the eroding value of investments like mortgage-backed securities, banks have less funds to lend. In banking, one dollar of equity typically is leveraged up into $15 of earning assets like business loans and leases.

A bank with $100 million in equity has $1.5 billion ($100m x 15) in earning assets. Now suppose that as a result of the loss on investments, the bank has only $50 million in equity. It can now only invest $750 million ($50M x 15). The worldwide banking system’s lending capacity is hundreds of billions of dollars less than just a year ago — even with the much publicized government bailouts.

Access to credit is only one of the challenges. More expensive credit is another. The turmoil in the credit markets means many companies are paying 1% or 100 basis points more (see our Fast Financial Facts to explore basis points) for credit. One percent may not sound like a lot, but let’s make it personal.

A monthly payment on a $100,000 mortgage loan at 6% is about $600. At 7% it’s $665! Now apply this to the trillions of dollars companies borrow each year. Rising borrowing costs are no different than higher raw materials or personnel costs. A company must find a way to lower these costs, offset them by reducing other costs or pass them along to customers. If not, profits shrink.

But where there are challenges, there are opportunities. To meet the challenges of constrained and more expensive credit, companies are seeking ways to not only reduce operating costs but also better manage operating assets like working capital (accounts receivable, inventory and accounts payable). One less dollar invested in working capital is a dollar less a company needs to borrow. So what can you do to help your clients better manage working capital?

Companies are zeroing in on their Cash Operating Cycle in response to tighter credit markets, higher borrowing and operating expenses and greater uncertainty. The Cash Operating Cycle  is the net number of days invested in Days in Inventories (DII), Days Sales Outstanding (DSO), and Days Purchases Outstanding (DPO). The investment in the Cash Operating Cycle is significant for many non-financial companies representing 20 - 30% of operating assets. 

The Cash Operating Cycle is driven by “What a company does” — industry association, and “How they do it” — management of underlying business processes. The Cash Operating Cycle for a grocer is very low since much inventory is perishable and consumers typically don’t pay on credit . Kroger’s is 14 days (33 DII + 4 DSO – 23 DPO).

Companies are better managing the Cash Operating Cycle by investing in new technologies and business solutions. And the benefits can be significant. Just a one-day improvement in each component for a $1 billion manufacturer of personal care products is approximately $15 million!

So how do your solutions help clients better manage the Cash Operating Cycle? FinListics can help you answer these important questions and provide items for action so you can cash in on cash operating cycles.