Part 2 of a 4-Part Series
Responding to the financial impact of the Covid-19 shut down and disruption requires a firm, unemotional response at a time when that is most difficult to achieve. In this series of articles on working capital management, Focus Management Group will address techniques and approaches for managing each of the components of working capital. The first article addressed accounts payable. Now our attention will turn to inventory.
Focus Attention On Inventory
The management of inventory during the phased return to new normal is more difficult than managing inventory during ongoing routine operations.
The first step is determining what customers will need to buy and when the purchase orders will be coming, and deliveries of product will be required. Purchasing rhythms that were repeated before Covid-19 cannot be expected to return quickly, if the pattern returns at all. The sales and marketing staff of a company need to be contacting customers on a regular basis to understand each customer’s unique needs during the phased return to the new normal. Different geographic regions will be returning at different rates and in different ways. A company must understand its customers’ needs in the immediate term – beginning with two to four weeks, and then looking forward to thirteen weeks.
How do you help your staff identify customer needs?
Provide an outline of what you need your sales and marketing staff to identify. Develop a script for your staff. Address topics such as:
What is the customer’s current level of your product in their inventory?
What is the customer seeing happening in the next two weeks? Ask for a regular planning call on at least a weekly basis.
How does geography impact purchasing needs?
Assure customers that your company is responding to the Covid-19 situation, and will be able to fill customer needs.
Explain you need assistance in helping to anticipate needs.
Communication is key during this time. Customers will be hesitant to commit to purchases. But, it is possible to anticipate needs if you understand what your customers are experiencing.
What analysis is critical now?
Companies will experience working capital stress during this phased return to business. It will be important to decide where to invest dollars. This is the time to understand customer and product profitability. And, to understand what changes are taking place as businesses return to work.
The combination of understanding customer and product profitability will allow your company to return to business with the best mix of customers and products that is possible. This is the time to use your Customer and Product Profitability Tool, or it is time to create one. We recommend a company review its products and customers to identify:
Phased in volumes of specific products, initially over a two to four week period and expanding out to a quarterly analysis.
Understanding run rates during the next quarter.
Identification of fixed and variable costs, at the new levels. Consider revised staffing, additional costs for testing and supplies, and other changes that will be expected moving forward.
Identify product mixes that will be required based on conversion from raw materials to finished goods to sales to cash.
Re-evaluate raw material costs.
This is also the time to evaluate vendors.
Communication with vendors was addressed in part in the Covid-19 and Working Capital: Managing Accounts Payable article published on May 5, 2020. Adding to the discussion regarding accounts payable, it will be important to also understand vendors from these perspectives:
For any single source vendors, identify alternative sources, if possible. Establish new relationships where practical.
For any long term single source vendors, talk to the vendors to determine their ability to meet your demands. Their ability to supply product may limit your ability to meet customer needs.
Work with vendors to provide short term and intermediate term suggestions of your activity with them.
Identify any supplier line of credit issues, and talk with vendors before problems surface.
Converting inventory to cash.
The Covid-19 impact on a company’s inventory can be enlightening. Most companies have a group of inventory items that turn quickly, and move through the company consistently. Most companies also have a subset of inventory that has aged out or turns very slowly. The subset of slow moving inventory is to a large extent masked during normal operations, and many ABL facilities do not age inventory in the same way receivables are aged.
This is the time to identify slow moving or stale inventory and convert that inventory to cash. While the borrowing base may be impacted if that slow moving or stale inventory has not been classified as ineligible, that negative effect needs to happen to generate cash from inventory that cannot otherwise be converted to cash. Selling $1 million of stale inventory for 50%, generates $500,000 of cash to use right now to repay a line of credit or to purchase needed inventory.
This is the time to identify any rebalancing of inventory. Overtime inventory purchasing timing and base quantities for production change. If your company has not recently analyzed and rebalanced inventory this is a good time to update that analysis – including new information on quantities and products from the sales and marketing staff’s discussions with customers. Changing the inventory mix to improve turnover by even two or three days of sales can have a material impact on cash flow. At a daily sales level of $150,000, shortening the operating cycle by two days generates $300,000.
Identify changes to lead times that may affect the flow of needed inventory through manufacturing or distribution.
Use all of this information to generate an inventory roll forward. It is in this step of working capital planning that an inventory rollforward needs to be developed, building on the accounts payable planning and rollforward that has already been completed.
Cash Planning: Is a Weekly Cash Flow Needed?
The importance of a weekly cash flow model has never been greater.
The first article in this series addressed accounts payable planning, and this article addresses inventory. The interconnection of all aspects of working capital is building. Future articles will address cash and accounts receivable. The key for a successful phase back into operations is a working capital plan, with a weekly cash flow forecasting tool as the roadmap.
With the accounts payable and inventory information that has now been accumulated, a company should know how it will be able to structure payments to vendors to ensure the inventory that is needed can be acquired. Both accounts payable and inventory should now be able to roll forward.
Next Steps
This level of planning can seem monumental, but it is extremely important now. We all have to manage cash as closely as possible, but also provide a roadmap to the return to new normal. Employees, customers, vendors and bankers will all be happier with a roadmap that outlines what will happen. The initial work to develop the roadmap, and even one aspect of it such as inventory, can be overwhelming. With a week of solid hard work, a company can develop its plan.
We are ready to help companies work through their cash flow forecasting and develop their roadmap to the return to new normal. Relative to inventory, this means we will need to develop the Customer and Product Profitability Tool to work in conjunction with the Accounts Payable Planning and Management Tool. We are able to work with companies to build their working capital planning skills.