Converting Your Assets to Cash--How Does Your Company Stack Up?
“Cash is king.” This common phrase captures the feelings of many manufactures I have worked with over the years. Companies with strong cash positions are able to invest further into their businesses or pay down existing debt. In addition to these obvious benefits, a strong cash position also can provide a business owner the peace of mind needed to sleep better at night.
Companies can measure how well they convert their assets to cash by maintaining certain activity ratios to compare themselves against past performance and the performance of others in the metalforming industry. To benchmark performance in this area, the annual PMA Benchmarking Report collects data on two of the more important activity ratios: the average collection period for accounts receivables, and the inventory-conversion period.
Average Collection Period
This ratio, also known as days sales outstanding (DSO), measures how long it takes for a company to collect its outstanding accounts receivables and convert them into cash. From 2006 to 2009, the average collection period trended downward to a low of 36 days in 2009. During the economic downturn, companies tightened their collection procedures, further reducing DSO. This trend abruptly ended in 2010, as efforts were relaxed and the collection period spiked up to 49 days, its highest point since 2006.
Best-in-class performance relating to this ratio ranged from a low of 22 days in 2009 to a high of 32 days in 2007. In 2010, best-in-class performance meant companies collected receivables 20 days faster than average performance.
Inventory Conversion Period
The inventory conversion period represents the amount of time required to obtain materials from a supplier, manufacture the product and sell it to a customer—the amount of time a company must invest its cash while it manufactures the product and converts it into a sale. The average conversion period has increased steadily from a low of 34 days in 2006 to a high of 45 days in 2010. Best-in-class performance here also had a steady incline from a low of 19 days in 2006 to a high of 28 days in 2010.
Benchmark Against Similar Companies
In addition to reporting the industry average and best-in-class performance for the entire population of participants, the PMA Benchmarking Report issues breakout reports that further dissect the information into several different categories, such as industry served (automotive, aerospace, appliance, medical, etc.), company size (based on net sales and number of employees), and type of manufacturer—stamping, fabricating, slideforming, etc. These breakout reports allow companies to benchmark themselves against companies with similar characteristics. Below is a look at the 2010 data for three of these distinct categories.
Automotive Benchmarked Against Nonautomotive
In 2010, 28 participants in the PMA Benchmarking Report identified themselves as automotive suppliers; 46 were nonautomotive. With respect to these two activity ratios, nonautomotive companies outperformed automotive companies in the average collection period by 13 days. With respect to the inventory-conversion period, automotive beat nonautomotive by nine days.
Smaller Companies vs. Larger
Smaller companies—those with less than $20 million in sales—collected their accounts receivables seven days faster than do companies with more than $20 million in sales. In contrast, larger companies proved more efficient with respect to inventory—inventory-conversion period for larger companies totaled 37 days, while smaller companies took 49 days to convert their inventory into a sale. This information is based on the data from 45 companies with less than $20 million in sales and 29 companies that reported sales exceeding $20 million.
Stampers Compared to Other Manufacturers
The first two sets of comparisons showed a significant amount of variation in performance between the different categories. Based on sample sizes of 54 metalformers and 20 other manufacturers, the last set of comparisons—stamping against other manufacturing—showed very little variation in performance. Stampers had an average collection period of 50 days, four days longer than nonstampers. Both groups had an inventory-conversion period of 44 days.
How to Improve Your Collections
According to Randy Bennett, co-owner of Automation Tool & Die, Brunswick, OH, it all starts by carefully selecting your customers. “You have to align yourself with the right customers, ones that share the same values as you,” says Bennett. “Additionally, there has to be trust. We are very selective from the standpoint of payment risk.”
Other items to consider when seeking to improve collections:
• Assign responsibility for timely and consistent follow up when payment is not received within agreed-upon terms;
• Ensure clear communications within the organization so that key people in operations—not just accounting—recognize the slow payers; and
• Use payment terms as leverage when negotiating pricing, especially when asked for concessions.
Companies also should look into various cash-management services available. Says Greg Ferrence, senior vice president of FirstMerit Bank: “Companies should look into a lock box and remote data capture as ways to help with collections. Also, taking credit cards as payment is an effective tool for slow-paying customers who always say ‘the check is in the mail.’ ”
Ideas for Reducing Conversion Times
Reducing the inventory-conversion period proves a bit more challenging, since this now involves the metalformer’s supplier. The concepts of lean manufacturing and the principles of supply-chain management are essential. Reviewing forecasts, staying current on trends with customer orders, and having access to real-time data also are important. According to Bennett, “You need to have a strong ERP system along with disciplined systems and processes, all of which are completely within our control…We brought certain operations inhouse, ones that previously were sent out to third parties, which helped reduce our conversion time and gave us more control over the process.”
Companies also can reduce conversion times by analyzing inventory by product type to systematically reduce slow-moving items, and by working with suppliers to improve their on-time deliveries in order to carry less inventory.Lastly, challenge volume-discount purchases—higher carrying costs often can outweigh the savings resulting from a lower purchase price. MF
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