CashFlow ABC

Forecasts are more accurate in the aggregate. But, for production planning, capacity planning and procurement you can’t use an aggregate forecast. You will need a tool to determine the individual SKU forecast so you may perform your planning functions that allows production to function. There are multiple versions of planning bills but for now we’ll focus on the easiest one which is a straight forward planning bill. First to use a planning bill you will need to divide your products into product families. APICS defines product families as “a group of products with similar characteristics, often used in production planning (or sales and operations planning). A planning bill uses past usage history to determine the percentages of sales within a product family. As an example, within the product family widgets the blue ones consisted of 30% of the sales, the red ones 20% and the white ones 50%. This history can be manipulated to take into account seasonality or higher or lower sales. Let’s say your sales group forecasts that the demand for widgets will be 1,000,000. When this planning bill is applied the forecast will be 300,000 blue ones, 200,000 red ones and 500,000 white ones. But it can go further than that. A planning bill can be a multi-level bill that takes into account further variations. Let’s say there are different sizes of widgets. Within the white ones ½” made up 60% of your sales, ¾ inch was 30% of your sales and 1” was the remaining 10% of your sales or white widgets. That would equate to a forecast of 300,000 ½”, 150,000 ¾” and 50,000 1” white widgets. Now, to make a widget you need the corresponding shim… I think you’re getting the idea. There’s an example of a planning bill on CashflowABC for you to use to see how powerful a tool this can be. Planning bills need to be reviewed and maintained on a regular basis. As you sales change so will your planning bills. Since a planning bill uses historic data to determine product breakdown within the product family you will want to weight the most recent data to capture the latest demand trends. There are many advantages to using planning bills. It helps to keep your forecasts accurate for the end items. They can be multi-level and even tied into your individual bills of material. It helps facilitate capacity planning and master production scheduling. The one issue you need to be aware of is variances in demand that equate to the overall product family forecast. As an example, let’s say that in the example given above your demand for ¾ and 1” white widgets was reversed from the forecasted amounts. The person or people initially accountable for the product family forecast will say that their forecast was accurate that it’s someone else’s problem. In this case, which is rare, someone needs to take ownership of it. Not to take the blame but to determine why so future forecasts and planning bills will be more accurate.

As with most things in life if you don’t measure it you don’t know where you are or if you need to improve.  While this can be bothersome in your personal life with measurements such as how much you weigh or your waistline it’s a necessity in business.  So we’re going to talk about several of the most common measurements regarding inventory and supply chain and their definitions.  While some are optional some are vital to understanding your inventory position.  There are also some that provide the same basic measurement just from different perspectives.  The first one that comes to mind and one that everyone wants to know is inventory turns.  Everyone from operations to finance wants to know the inventory turns, usually from very different perspectives.  The definition is obvious, it’s how many times you have “turned” or sold through your inventory within a given time frame.  The formula is the cost of goods sold for the time period divided by the average inventory value for the same period.  So, if the CoGS was $1,000,000 and your average inventory was $250,000 the calculation would be 1,000,000 divided by 250,000 which equals 4.  The inventory turns in this example is 4.  There is only 2 ways to increase your turns; increase sales (without increasing inventory) or decrease inventory.  There is another way to view this measurement as days of inventory.  If the above example was for a four week period instead of saying you have 4 inventory turns you have 1 weeks worth of inventory.  You can calculate turns using retail value, cost value or units as long as the unit of measure is constant.  Another common measurement is quantity on hand.  This can be broken down to raw materials, WIP, components, replacement parts and finished goods.  This could also include available to promise which is the uncommitted portion of your inventory or the inventory that isn’t needed for current customer orders.   The next measurement is inventory value.  We’ve discussed this in past episodes but it fits in here as well.  You can measure the inventory value either at cost or retail value.  Some companies like to value inventory at cost to represent their investment while others like to value inventory using the retail cost to capture the total value of the inventory including their profit.  Because value changes over time a valuation method will need to be employed to capture this change or to standardize it such as FIFO, LIFO and standard costing.  Inventory accuracy is measured by performing cycle counts and is reported in 3 different ways.  The first is overall accuracy; this is the number of locations counted without discrepancies divided by total number of locations counted.  As an example, if you count 50 locations and 49 of them are without discrepancies (the counted item matches the perpetual inventory) your inventory accuracy is 98%.  The other two ways are by number of units and by cost.  Both of these measurements should be measured using absolute numbers.  In other words, no negative counts.  Whether you’re short 3 units or over 3 units the variance is 3.  If you take into account if a variance is positive or negative opposing variances will cancel each other out.  It reminds me of the old joke of the 3 accountants that go bow hunting together; the 1st accountant sees a buck in the distance, he draws his bow and fires missing to the left of the buck.  The 2nd accountant draws his bow and fires missing to the right.  The 3rd accountant exclaims, “You got him!”  There are other measurements but we can cover them later.  If you have questions about what we’ve discussed here today or if there is another measurement you would like to know about please send us a message at www.cashflowabc.com.

This week’s episode is an open forum discussion regaring the pros and cons of physical inventories and cycle count programs.  We discuss why physical inventories need to be performed, the benefits of cycle count programs and what must be accomplished before physical inventories can be replaced with a cycle count program which will save you money and improve your CashFlow.  So, listen to the episode and turn your cash flow into a cash flood.  Or at least stop the leaks. Thanks for listening, John & Dave

The How & Why Direct vs. Indirect method Net Income & adjustments Cash from Operations a. Sources & uses of cash b. Prepaid expenses c. Accrued expenses d. Accounts Payable e. Accounts Receivable Example:  think about a $150 invoice from an electrician to fix a light switch. The work is performed in March and you have net 30 terms. In the Statement of Cash Flows, the effect of the $150 in March is to reduce net income by $150 and, because you have net 30 terms, it would be a source of cash in Accounts Payable because you didn’t pay for the expense. The effect on cash in March is zero and is shown by a “use” in the reduced net income and a “source” in the increased Accounts Payable. In April, when the bill is paid, Accounts Payable is reduced which becomes a use of cash on the Statement of Cash Flows. Cash From Investing Cash related to investing activities is the change in long-lived assets Cash from Financing Cash from financing reflects any activity in the equity (excluding retained earnings) section of the Balance Sheet or changes in any long term liabilities such as notes or bonds payable. Change in Cash Ending cash balance in your general ledger minus beginning cash balance. All cash accounts should be included – general accounts, Accounts Payable accounts, Payroll accounts, petty cash – all accounts that had any balance. Example: Cash Flow Through a Retailer  From a cash flow perspective, it doesn’t usually get any better than retailing.  In a perfect world, everything purchased from suppliers would be on net 30 terms and inventory would turn more than 12 times per year.  In this scenario, the customer would be buying the product (usually in cash) from the company before the company paid for it. At -15 days (fifteen days prior to the sale) $20 is paid – this could be phone expense, wages (related to purchasing or receiving the product), etc..  At 0 days (the day the sale happens) another $17.50 is paid out in expenses related to this sale.  Once again, this could be wages, advertising, or any other non-product expense.  The sale was in cash, so $150 is received from the customer, putting the retailer at a $112.50 positive cash position (150-20-17.50).  At +15 days (fifteen days after the sale) the product that was sold is paid for at $75 and another $7.50 is paid in related expenses, leaving a net cash increase of $30, which is equal to the net profit on the sale.  As you can see, in an ideal situation, only minor expenses are paid for prior to the sale.  This example is only an example – many retailers have significantly lower turns and have to carry those costs in advance of a sale.  This is the reason that the Finance Department is always pressuring Operations to reduce inventory and many deep discounts can be found on slow moving inventory.  It is also the reason that many retailers fail – too much cash was tied up in slow moving inventory and the business found itself undercapitalized.

The Statement of Cash Flow is the evolution of the Statement of Changes in Financial Position. It is a highly useful tool within the guidelines of Generally Accepted Accounting Principles (GAAP) to effectively analyze the operations of an organization from a financial perspective. It is a common, and true, statement that “Cash is King”. This is why the Statement of Cash Flows is so important. When you understand what it’s telling you it becomes an enlightening view of the company. It is as if you have been going through a room in the dark for years and then you see it with the light on. One of the companies where I have been Controller had a division that was privately held prior to it’s acquisition as a division of our company. The company ran about 40+% gross margins with 20+% net margins and wound up being acquired by our company for the amount of its’ debt to us. How could this highly profitable company come to such a demise? The company was excellent in sales, marketing, pricing, and product quality but what they didn’t do was effectively manage the inflow of cash into the business and it cost them the business. By understanding the Statement of Cash Flow and looking at the information as it applies to your organization you can greatly increase value and longevity for your company. The objective of the Statement of Cash Flow is to show you both where your cash is coming from and what you are spending it on. That is it plain and simple. By seeing the numbers quantified it will, to a large degree, confirm what you already know – it may be that all of the cash is coming from the bank or investors and the money going for capital investment or customer financing. The Balance Sheet is a point-in-time report providing a birds-eye view of the financial health of the company while the Income Statement is an operational report telling how well the company did over a period of time. The Statement of Cash Flow is the bridge between the Balance Sheet and Income Statement and, like the Income Statement, is an operational statement and completes the picture of what happened in the business from one Balance Sheet to the other. Knowledge is power and cash is king. Treatment of Revenue & Expenses Components of Net Income Usually a Source of Cash Treatment of Assets Types of Assets Usually a Use of Cash Treatment of Liabilities Types of Liabilities Usually a Source of Cash Treatment of Equity Types of Equity Accounts Can be a Source or Use of Cash Operational Impact Effects of extended terms to your customers (A/R) Effects of extended terms from your suppliers (A/P) Effects of high Accounts Receivable and/or Inventory Effects of lowering Working Capital Digging out of a cash hole For further explanation and illustrations, check out Understanding Cash Flow