Ah the good old days, when your business was small and simple. Now you’re growing like crazy, but you’re feeling like your cash flow is dying the death of a thousand cuts. You are growing but cash is scarce.
As you grow, there should be more cash from higher profits. You should get leaner, with better margins, due to efficiencies, right? If that isn’t happening, and you’re like most other scaling businesses, then let me show you some ways to analyze your business to find and clean up some of the leaks that eat away at your profitability and cash flow.
We’re going to look at the speed and efficiency of your operating cycle. Hang on to your hat.
3 Ways to Watch the Operating Cycle
As your business grows, you increase the number of your customers, people, product, processes, systems, and more. Simply put, this translates to increased complexity. And this complexity begins to have unintended consequences to your operating cycle: that is, it starts to expand.
The longer your operating cycle, the more expensive it is for you to grow. Said another way, the longer your operating cycle, the more cash you need in order to grow.
So what you are seeing and feeling is real—good growth, but increasingly strained cash.
One of the best ways to begin to address this complexity is to measure and understand the components of your operating cycle. The term “operating cycle” can mean several different things. The one(s) you should track depends on how your orders, services, and billing are structured. Here are three to consider:
1. Money out to money in (cash cycle).
This cycle begins when you pay (cash out) for something like raw material inventory (in a goods business), or payroll (in a professional services business), or marketing spend (in an ecommerce business). The end of the cycle is when you get paid by your client. Obviously, you want this to be as short as possible.
2. Order to cash cycle.
It’s a slightly different perspective from the cash cycle, above. Once you receive an order from a customer, how long does it take for the cash to come in? For most ecommerce companies, it’s almost immediate: orders get shipped out same-day or next-day, and you can charge a credit card right away. That’s great, so this might not be the best cycle to analyze in ecommerce.
But I’ve worked with plenty of companies with a much more complex response to an order. They might have to order equipment, configure it, hire people, and coordinate a multi-step delivery of the service or the job. That’s when watching this metric helps.
Let’s say you install commercial and residential fencing. After a customer order is received, you might have a scheduling backlog. You might have to find a crew, move (or lease) equipment, and buy fencing inventory.
Due to the complexity that you have to coordinate (as you grow), your new client’s install is scheduled a couple weeks out. Maybe you take a 50% deposit from the customer and you get the other half at completion. The backlog from the complexity is adding to the order-to-cash cycle significantly. The upfront deposit in this example, however, helps offset a good portion of the cash tied up in this cycle.
3. Sales cycle.
Another operating cycle looks at the time between the initial sales contact to the customer order. How intensive is your sales process in terms of resources and time? As an example, one of our clients had several field reps doing initial sales calls, which involved product features & benefits, pricing responses, and various other “early” information gathering.
The field reps were backlogged with top of the funnel requests. Because of these backlogs, the company moved the qualification stage of the sales process to an inside sales resource. This inside sales rep increased the efficiency of qualifying customers and became the expert. Qualified customers were then handed off to field reps, which increased their efficiency. The overall sales cycle for this company decreased dramatically, which substantially increased revenues relative to sales expense spend.
Operating cycles serve as strong, proactive metrics to help identify emerging problems in a growing business. Depending on what industry you’re in, the source of improvements may vary.
Let’s look at some questions to ask.
3 Questions to Ask about Your Operating Cycle
Your job is to understand which operating cycle is key for your company, and then to measure/monitor that. How is it trending?
When a business is simple, in its earlier stages, it’s good to build these metrics and keep an eye on them, in terms of weekly, monthly or quarterly reporting, because then you can see when the trend line starts to shift.
As companies grow in complexity, things start to slip and your profitability can leak in many small ways. For example, you used to install five fences a week and you had a 35 day order-to-cash cycle. Now, you get 50 fence orders a week and you’re 53 days from order to cash! Time to ask, “What can we do differently to get it back down?”
Here are three questions to ask yourself.
1. How efficient is your performance?
What’s the overall performance of the business? Are you scaling well? Are you able to grow the business and keep these operating cycles in check? When they expand, you lose control of your cash. And cash is key to growth.
Here’s an order-to-cash cycle example. For every order, one of our clients had to customize equipment. To avoid tying up cash, they kept a low inventory. As orders got larger, however, it would push them out of stock, and their order-to-cash cycle (in terms of days) would go up because they were waiting to ship. Or if they had equipment to configure on a client site and their team was overscheduled, then implementation would be delayed, which meant they couldn’t bill the client and collect the cash.
By looking at that cycle, we identified some bottlenecks where they could improve their operations to shorten it.
2. How can you maximize the time value of money?
You also want to keep your operating cycles in check because when you get down to it, the time value of money is important. If you have a longer cycle, money is stuck somewhere, right? That could be in inventory, or in accounts receivable.
Or that money could be stuck in a low-velocity sales process, when it takes longer to get deals closed, clogging the sales process.
Improving the velocity of the sales cycle is always a good thing.
For example, one of AVL’s clients buys lots of small pieces of equipment, about $500 each, which they lease out at a rental rate. As they scaled, they bought these items in bulk, 200-500 at a time, to reduce unit costs. The challenge was that you’re talking about tens of thousands of dollars out the door at a time, upfront. Then those units sat on the shelf for several months.
We also noticed their gross margin calculations did not reflect the holding cost of that inventory. We added a time value of money “tax” to the inventory, which helped the owner realize how much his big inventory was costing in cash flow.
To fix the first problem, he went to his equipment supplier and said, “I’m going to commit to a certain buy for the year, but I want to take delivery and pay in smaller order quantities.” So he kept his bulk pricing and was able to get it delivered in increments of 25. That dramatically freed up cash and let him grow again.
3. What capital do you need to grow and scale?
It’s not only the money that’s in the business. You need capital to scale your business. Yesterday we talked to a services company that, after an order, has to pay payroll. They also have to pay for media buys in advance of closing the deal or getting the cash from the client. What’s that time span between money out and in?
Cash is limited. You can’t go nuts on buys before your customer order or you’re upside down on your cash. We built a model so they could see their capitalization requirements. We put all those assumptions on one page and said, “If the business grows like X and we have Y many people and are able to sell Z quantities or do Z hours of work, here’s what it looks like from a cash requirement perspective.” It showed them exactly how much capital was required to grow and scale.
Another AVL client had large projects, 100 days long with a $50,000+ price tag. They contracted with new clients to receive a deposit payment (in cash) before they bought equipment for the project. In reality, however, the clients took two weeks to pay the deposit, putting the project two weeks behind schedule to start. They asked us: should we build a business where we scale in a healthy way, or should we make huge purchases before receiving the customer’s cash?
Our answer: You want to scale your business to have more capital. If you have only 90 days to finish a project, you don’t want to wait and wait for cash to come in.
Here’s what we found. Pretty early in the sales process, they knew what equipment they needed to buy. We suggested that when their client says go, they should say, “Okay. As we continue to negotiate the contract details, if you want to get started right away, we’re going to send you an invoice due upon receipt that’s your down deposit on the deal.”
Now they could buy all the equipment on day one, rather than lose two weeks waiting for a check. By looking at operating cash cycles, we figured out a new way to work with their customers to shorten the cash cycle by two weeks—that means more cash and capital to enable the business to grow and expand!
That’s the magic of watching your operating cycle.