What you sell is the nuts and bolts of your business and you must keep this area running efficiently and securely. You cannot afford to under invest but similarly there are usually operational efficiencies to be found in how you manage your products and services’ cost during a crisis.
How do we navigate our way through this economic turmoil? How do we ensure that our businesses survive in order to provide us and our employees the ability to enjoy a full and safe life outside the workplace? How do we ensure that our businesses will in fact prosper, or at least be positioned to prosper, in the future? The bottom line is that we can’t simply rely on the things we’ve done in the past or on government assistance alone to get us thru this Covid-19 crisis. We should instead use this time to evaluate every aspect of our business and chart a course for the eventual recovery from this crisis.
We decided to dedicate a series of blogs to offer some clear and concise ways for a privately held business how to re-examine itself, to identify the key elements of its success, to develop strategies for ensuring its survival during economic turmoil, and ultimately to build a plan for thriving in the present and the future. In part two of this series we will focus in the need to examine the cost of your Product and Services‘.
I. Careful management of inventory levels will be needed as demand may decline and you could end up holding excess inventory, tying up much needed working capital.
The calculation showing how long inventory is sitting on your shelves is called inventory turnover and can be stated in two ways: the number of times you “turn over” your inventory
holding each year, or the average number of days you hold inventory before selling it.
While the absolute numbers are important and can be compared to industry averages, in the current environment it is the trend that you should be watching. If inventory turnover is reducing or
inventory days are increasing, this is a warning sign. It is possible for inventory turnover to fall even if the level of inventory is reducing. Watch this as it means your sales are falling at a greater rate than the reduction of inventory, and this will lead to a cash drain in the near future.
Inventory Turnover = Cost of sales for the period / average of inventory at the start of the period and end of the period
Inventory Days = 365/ inventory turnover
II. A closer look is also needed for R&D, Product Development and Business Development activities.
The business case that the original decision was predicated on may have changed significantly, and certainly predictions of revenue may now be less certain than you first thought.
If a project is not going to provide a short-term positive cash return, you should seriously look at deferring it. While there is usually an additional cost to stopping work and restarting it again, the de-commissioning and re-commissioning costs may be acceptable in relation to the savings from deferring the development costs. This applies to any expansion activity that requires investment up front (and it doesn’t matter whether that is capital expense or operating expense investment) with the returns to follow over time. Payback period is the calculation needed in these situations.
Payback Period = the amount of time it takes for the initial upfront costs to be paid back. Pay back periods usually are several years so there is the following shorter-term alternative that may be more relevant in the current crisis.
Time to Break Even = the time it takes for the project to generate enough cash to be cash positive.
III. Become best friends with your suppliers and communicate with them regularly.
These people become first port of call if things get a bit tight and they react better if they know what might be coming rather than finding out when the problem has reached a critical
point. There are two useful measures that you can use to monitor how the business is traveling in this regard.
The first is an aged list of payables very much like you (should) have for your receivables. Talk to those suppliers who are sitting out in the 60 days or older columns. Not talking to them makes them very nervous, and many businesses have been taken down by suppliers who would have been far more understanding had there been regular communication. Check the list in relation to the credit terms you have with each supplier – some payables have very short terms (often tax payments) and other creditors can live with being paid
on longer terms.
If you are having short-term cash flow problems, choosing one large creditor and negotiating a payment plan (even if this involves paying some interest) may be a better alternative than aggravating a large number of suppliers and developing a reputation that might inhibit supply of goods. A bad reputation is quickly gained but takes a long time to lose. And if things are tight, you
need your good name.
The second measure is an average number of days it takes you to pay your creditors (Payables Days). This is useful because it tells you how you are trending and if this calculation is rising then you have problems. Like all working capital calculations you work out the turnover rate for the item and then convert this to days outstanding.
Aged Payables Listing = typically payables are grouped into 30, 60, 90+ days but the key thing is that most suppliers count the days from the date of invoice, not end of the month of purchase.
Payable Turnover = total purchases for the period covering trade payables (including materials, supplies and any sub-contracted components) / average of accounts payable relating to these items at the beginning and end of the period.
Payable Days = 365/payables turnover.
If products and services represent the nuts and bolts of the business, marketing and sales is the engine room that provides the drive for the business. In a classic episode of the TV show ‘Yes Minister’, civil servants argued that the best run hospital in the health system was the one which had no patients. They had lost sight of what it was all about. In tough times it is quite vital that you do not lose sight of the importance of customers and sales. We will cover these key topics in Part Three in our series