Sales, Profit or Cash?
At Goldratt India, we’ve been working with organizations for over 22 years, to increase sales, profit and cash by an order of magnitude. Since 2015, our focus has shifted from increasing EBITDA/ sales, to increasing cash in the bank. Money in the bank is vey simple to measure. We do not need any financial accounting for this. If a company has generated cash – either the bank balance will increase, or the borrowings will reduce.
The conventional belief is that more sales translates to higher profit or more money. This assumption is often correct though not always. Increase in sales and EBITDA do not always lead to more money in the bank. Companies can get into a cash crunch, if they increase sales without assessing increased cash requirement for additional working capital.
Cash in the bank is impacted by two parameters, one is the EBITDA, and another is change in working capital. Often, EBITDA is less than the increase in working capital. The net result is that instead of depositing more money in the bank, the organization has withdrawn money from the bank.
Our clients have achieved some very significant successes in shrinking working capital including inventories (RM, WIP, and FG) by about 30-40% in one year. With a tax rate of approximately 30%, reducing inventories/ working capital by Rs. 100 crores is equivalent to increasing EBITDA by about Rs. 140 crores in terms of cash in the bank!
The reduction in working capital requirements has several benefits. First, it helps organizations build a cash reserve to manage during uncertain times. A company that has a strong cash position can also support its vendors by providing them timely payments and get material on time, more frequent deliveries, lower MOQ (Minimum Order Quantity) etc. Second, with improved working capital turns, the incremental increase in working capital with increase in sales is also reduced. These factors are critical in helping the company to build capability to provide a very fast response to customer requirements. Irrespective of the market conditions, it helps the company to take advantage of new opportunities and continually improve cash flow.
Before increasing sales, our recommendation is to first improve working capital turns. Thereafter, increase sales slowly, keeping a hawk’s eye on the cash in hand. Further increase in sales or investment, can be funded by the cash generated from operations including working capital reduction.
Authored by – Ravi Gilani, Founder & Managing Consultant, Goldratt India
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