Cabinet Makers and Small Business Cash Flow
We mentioned in our first article, our roots are deep in a few industries, and woodworking, specifically cabinet making, is one of them. Cabinet makers are simply some of the most resourceful, hard working groups of small business owners out there. And their industry has some unique challenges,. However the primary one isn't unique to their industry, it is common to all small businesses. The flow of cash in, through, and out of the company is critical to the health and success of the organization, but it is very hard to manage without the right mindset and tools.
We want to expand on this and discuss the basic steps that organizations can take to improve cash flow. Here is our quote from the previous article:
Cash Flow Crunch: Every payday was a "fire drill". The nature of being a subcontractor to residential construction simply creates a cash flow problem. Most builders are taking monthly draws at best, and yet the Cabinet Makers are paying out payroll and materials weekly. In essence, the operation is a bank, lending their customers capital for weeks, even months at a time before truly getting paid. Add growth to that equation, and the problem is even worse.
Where does the cash flow in a small business?
Clearly cash comes in from SALES, and goes out on EXPENSES. That's the most basic element to cash flow. So the conclusion to most businesses is that as long as what goes out is less than what comes in, things are good. Right?
In some sense, that may be true, but what gets overlooked is how much cash is tied up in the operation itself, and the timing of how the cash moves around. Let's take a little deeper look at this, and describe some tools to help address the problem.
You have a secret bank account, hidden in (mostly) plain sight.
If you can state with any decent level of accuracy the value of inventory you have on hand right now, skip this section. You already know the problem, and have a solution. While it might take a few days of work a month to get the number, if that number is close to accurate, you have a key element in solving this problem.
Inventory, essentially the raw materials, in process work, and the finished goods laying around waiting for someone to buy them, is essentially CASH. And it is CASH you DON'T have in your bank because you already spent it. When you purchased more materials, or paid your team, overhead, machine payments etc... and/or converted it into something else, you simply took cash and transformed it into something else. Because you haven't received any cash for it (in hopefully it's new, more valuable form!), a huge portion of your organizations cash is "tied up" in a form you cant do anything with.
Managing Inventory is a constantly changing game for most manufacturers, and for any group doing custom or semi-custom work, it can be a lot harder. While there certainly are multiple facets, in a small business Inventory Flow is essentially small business cash flow.
The #1 rule of Inventory Management
Never run out of inventory
Why? The problem is usually 2 fold:
- If you don't have raw materials, your labor force (which is typically a bigger piece of the costs/more expensive than the materials in cabinet making) will be standing around with nothing productive to do.
- If you have no finished goods to sell when your customer wants it, you cant convert all your hard work into more cash than you paid.
Running out of inventory (at the right time, but more on that later) is a big problem, and one that must be avoided at almost any cost.
The #2 rule of Inventory Management
Never have more inventory than you absolutely need
Why? This problem is essentially what we discussed at the beginning. Inventory is cash you don't have in your bank. Holding any more inventory than you absolutely need is keeping cash out of your bank account, and therefore out of your pocket!
How to manage inventory
Inventory is the result of transactions. This means that it is dynamic, and must be calculated. The historical counting it once a year and leaving it at that doesn't help you understand what is going on right now. Stopping everything and counting inventory right now is also prohibitively expensive.
The solution is having a system of tracking the "ins and outs" of your inventory, and attaching a value to those transactions.
The IN: Purchasing and Manufacturing
When you purchase something, you essentially commit to paying for something. When it is received, that product is part of your inventory. Normally, you pay the bill within a fixed amount of time, in some cases you pay immediately. But for arguments sake, let us assume we have classic "Net 30" terms. We pay for the goods within 30 days of receiving them.
We need to track when this product is received. When did it join your inventory? How much? At what cost to you?
If you aren't using a database system like our Software Toolkit, you will quickly figure out this is almost impossible. You can make lists, spreadsheets, even marks on a wall or pallet rack, but it is prone to error and labor intensive to maintain. Writing Purchase Orders, and Receiving them is the fundamental step to Inventory.
Assigning a vendor promise date to each item on a Purchase Order begins to develop a key practice that will take the idea of managing inventory even further, not just counting but Inventory Planning. Knowing not only WHAT you ordered, but looking ahead at How Much and By When materials will come in opens up a tremendous opportunity to manage inventory.
On the manufacturing end, you also add to your inventory by making something. You basically add value to something through labor, and now have something new. For Project based manufacturers (think custom), they don't really have Finished Goods with part numbers, but the products ready for a project have essentially become a value of inventory until sold.
The Out: Sales and Manufacturing
When you ship something, you "relieve" inventory. You exchange the inventory you have for the customers commitment to pay you. This inventory is either a bunch of part numbers, quantities, and prices or could be a project representing many items that are not treated as part numbers. Either way, until it is sold, this is inventory.
When you manufacture goods, you relieve the inventory of the raw materials as you make them into new things.
Add it up.... and then adjust
Simply adding the ins and the outs gives you an approximate number of inventory. If you were to take that amount and then go out to your shop floor and count an item, you might see that what you count is not what your system shows you. This can be from errors, scrap/quality issues, work flow, and theft.
Errors: Did someone order 100, received 100, and really only got 85? These errors can happen, and most systems have elements in place to minimize them.
Scrap/Quality: Was there a problem in manufacturing that required someone to use more than what was originally determined? Did you receive product from the manufacturer, but it wasn't acceptable?
Work Flow: Did you pull inventory off a shelf, but didn't report it to the system yet? This is normally called Work In Process (WIP), and requires some kind of Work Order step in your system. Think of this as a Purchase Order to yourself for goods. We will address this more in depth in another article.
Theft: Is product moving out the back door for someones side jobs? Does someone have a "special arrangement" with the delivery person or vendor and you are paying for it?
Most systems have the ability to adjust the inventory when something like this happens. As well, regular counting allows you to make these adjustments and see if problems are happening. There are strategies for counting,a s it can be very costly to have everyone stop and count. One great way is to simply identify the materials that cost the most, and the materials that you use the most, and count them. Combining the 2 elements, and only counting the high turnover, high dollar materials should happen most often, and then as materials represent less and less of the value and activity, they get counted less often.
Basic Inventory Summary
So knowing how much Inventory you have is the best foundation for looking at where cash got "trapped" inside your organization. If you have inordinate amounts of a material, you need to examine why. Did someone purchase a whole lift because they were afraid of running out, only to find out you wont use it all for another 6 months? Are you switching to a new hinge, and have a lot of the old one left over? Do you not have enough of the new one for upcoming orders?
Tackling Inventory at the basic level can be hard work, but it sets the stage for cash flow management. Next we will talk about how to take that information, and supercharge it.
Inventory Planning.... the next frontier...