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Sustainability: Moving from Common Sense to Common Practice
2016 International Conference
Leesburg, VA - National Conference Center

September 18th - 21st

Quick Decision-Making in a Cash Constraint Situation Workshop

Ira Gilani Lal - TOC Consultant / Pharmaceuticals, Apparel, Retail, Communications and Technology Sectors

Initially, when an organization starts making losses, it starts withdrawing from its past reserves. Over a period of time, as past reserves are exhausted, working capital starts getting depleted in a non-linear manner. Even before a company gets into a cash constraint, it has cash shortage. At this point, the company is precariously balanced. A small increase or decrease in cash can make or break an organization.

Workshop Methodology
Participants will be introduced to the importance of cash through an interactive computer based Casino Game. The simulation will help participants understand basics of cash allocation and cash flow planning at an individual level.

In this workshop, participants will be guided through a case study and go through various scenarios using a Cash Constraint computer simulation to understand the impact of cash on throughput, on time in full (OTIF), sales and profit. Some of the important questions that would be answered are:
  1. How to prioritize and allocate cash among different orders?
  2. How to induct additional cash – several small amounts or one-time large induction of funds?
  3. What is the right rate of interest to borrow money?
  4. Does it make sense to provide discounts to customers during a cash constraint?

What to Change
Cash shortage is like a ticking time bomb and quick decision-making is crucial. Despite early warning signals, several business leaders remain unaware of the real issues and are unable to take steps for course correction.

Often, organizations are unable to assess increased cash requirement while increasing sales, or chasing market share. In some cases, small and medium enterprises (SMEs) that are dependent on just a few big customers accept unfavorable terms in a bid to increase sales, and it increases the squeeze on cash. When the organization does not have enough cash to sustain increased sales, there is high probability of the organization getting into cash constraint. If there are investments on increasing capacity, stress on cash will be more severe. In their quest for growing fast, many companies invest without comprehensively looking at cash flow for various scenarios.

An organization has a cash constraint if and only if all the following conditions are met:
  • Sufficient orders
  • Sufficient equipment, manpower and other resources including space
  • Right vendors are available but will not give credit any more
  • Insufficient raw materials and packing materials
  • Additional cash cannot be easily arranged

Simply put, an organization is facing a cash constraint when it has sufficient orders, i.e. OTIF < 95%, enough manufacturing capacity, that is, no machine/ equipment/ resource has overall equipment effectiveness (OEE) > 85- 90%, a reasonable number of right suppliers, and yet it suffers from material shortage as vendors refuse to give any more credit.

What to Change to

The main obstacles in overcoming cash constraint are the local measurements (sales, market share, tonnage, freight cost control and interest cost control) that organizations continue to improve when in cash constraint. Continuing to use the same measurements leads to further deterioration of the situation.

The key parameter that needs attention is the cash velocity. Cash velocity is defined as an increase in cash per unit of cash in one period of time. Let us assume that the totally variable cost (TVC) is 50% of sales and the time from cash outflow to cash inflow is one month. In other words, a cash induction of $50 will become $100 in one month’s time. Here, the cash velocity will be 100% per month. Even a small increase in cash increases sales, throughput, OTIF and profit significantly. In most cases, it may be possible to overcome cash constraint in less than 13 weeks by increasing cash velocity. Some of the suggested means for increasing cash velocity are: reducing customer payment time, shrinking manufacturing lead-time, and reducing supplier lead-time.

In most situations, recognizing that cash is the real constraint and exploiting and subordinating all organizational measures and policies to the cash constraint will shift the constraint either to orders or operations within 13 weeks. However, in extreme situations, it may be necessary to induct additional cash. For stressed organizations, cash may be available only at a significantly higher rate of interest. Here, we must understand that for most organizations, cash velocity varies from 10-30% per month. Hence, it makes sense to borrow even at a very high rate of interest, as long as it is less than the cash velocity. Another caveat is that partial induction of cash will not work. Either induct the total minimum required cash or none at all.

How to Cause the Change

It is not just finance managers, but the entire top management team that needs to get involved to create cash flow statement for next 13 weeks or one quarter and make a plan of action. There are challenges in creating this statement sometimes due to distortions in financial reporting (such as inflated or obsolete inventory being shown on books). There are also significant differences in total receivables and collectible receivables, and disagreements between accounts and sales.

It is of utmost importance to create a sense of urgency, be transparent with employees, modify current measurements, and take corrective actions to overcome cash constraint in a short period of time. We also recommend creating a weekly dashboard for monitoring key parameters such as free cash flow, overdue payments cash in hand and stop measuring sales, market share, and local parameters such as efficiency.

Ira Gilani Lal has over ten years of experience across Pharmaceuticals, Apparel, Retail, Communications and Technology sectors. Prior to TOC consulting, Ira was a Consultant at Accenture’s Corporate Strategy practice. At Accenture, she worked extensively with Indian as well as international clients. Her industry experience includes working for India’s biggest pharmaceutical companies, Dr. Reddy’s Laboratories and Ranbaxy. Ira is an MBA from IIFT, New Delhi.

Ira is passionate about spreading TOC to a wider audience in India, and has been invited to share her experiences at several industry bodies and institutes. She is a member of the Manufacturing and Industry committee at BCIC (Bangalore Chamber of Industry and Commerce). Ira has also been a co-authoring articles on TOC for India’s premier magazine, Outlook Business.

The articles on published cash constraint can be accessed at the following links:

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