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6. Seven Drivers of Cash Flow
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Transcription - Seven Drivers Of Cash Flow
Darryl: Hi, welcome back to the second in our series of business acumen and explanation of our Formula. So in the previous video, we touched on the financial intelligence and we talked about cash flow. The focus is on cash flow, and during that discussion, we talked about strength versus speed in term of cash flow for your business. So we're now moving into the second video, which is about strategic execution, and I'll hand it over to Scott.
Scott: Yeah, thank you Darryl. If you remember from the last video, we talked about strength and when we use our river analogy. That's how deep and how wide the river is, so how much volume of water, or in this case cash flow is moving through your business, where speed is how fast that river is flowing, so how long it's taking from when you pay for your stock or you deliver your service, till the money gets to the bank. We're going to look at the seven levers, so we split them up into four for strength and three for speed. There's a man called, here in Australia, called Alan Miltz, and he calls this the power of one. He's referring to how much extra cash you're going to have in your business if you change something by either one percent or one day. And that really fits within, with our philosophy, when you're making changes you're doing the one percenters.
Darryl: Yes, so yeah, so as we go through the videos, you'll see our reference time and time again about incremental change. It's easy to see through incremental change whether you're heading in the right direction, or conversely, to pull back if you're actually heading in the wrong direction.
Scott: Yeah. Excellent. Thank you, Darryl. So we're not going to really focus on the financial aspect of these things, because we're really focusing on the strategic execution. However, there is a tool, and I'll put the link up on the screen, the National Australia Bank have a tool where they have these seven levers, and then you can put your financial information in and then change something by one percent and it'll do it for you.
Darryl: Right, so this would really be a real tool to sit down and actually play with some numbers and see what you get in your results, because if we're looking to increase that cash flow, we can almost predict ahead of time what sort of result we might get. Then we'll know that, well let's put the effort into that area.
Scott: Yeah exactly, but what we want to focus on today is the activities that go into these things. We're not going to, we haven't got all day, so we're just going to focus on one. But let me quickly just go through the seven different levers.
Scott: So the first one is price, is changing price. Changing price can either go up or go down. If you're increasing price, you want to know what a ... Because price is also affected by or may affect quantity, it may affect it well or it may affect it adversely. One example there is, when I first started I had a mobile bookkeeping business back in 1996. This is before.
Darryl: In the old days.
Scott: In the old days, before there was only like six people listed in the yellow pages in Townsville, where I grew up, so bookkeeping wasn't all that fashionable back then. One of my friends, he bought a little corner store. Obviously, we're going back to the old days again when corner stores were all around. He was, because we both worked in retail four, five years, he had quite a bit of knowledge, so he bought a big pallet of Coke, and he put the price at $1.80, which was similar to what was just down the road. It moved nowhere. So the next week, he increased the price to $1.90, and it just flew out the door.
Darryl: So why'd he know to do that?
Scott: He just thought he'd try. Just like we keep saying, you need to do simple tests and measure, and that's what he did.
Darryl: Interesting enough, most people would think they'd have to discount, wouldn't they?
Scott: And we'll talk about a little bit later in this episode about price and how to discuss it, but prices moving up and down, and it doesn't always have to be down. Quantity, quantity comes back to Jay Abraham's three ways to increase your business, increase your number of customers, increase how much they buy from you and how often they come back.
So we need to link those things back to what are the activities though. Trying to get new customers, do you have a referral program or how often do they come back? Are you having seasonal or are you sending out newsletters or all those sort of things?
The third one it says COGS and cost of goods sold, direct costs, so those are things are relating to your products. It's making sure that you, getting a good price or getting a good discount or a ... We'll talk about it a bit later, but just relating it back to your price or your quantity, or relating it to your customer value proposition. You're buying the stock or providing the service that related back to your strategic plan.
Then there's operating expenses and we all know about those.
Darryl: Moving on.
Scott: Moving on, yeah, so on to speed. There are accounts receivable, and so-
Darryl: It's a big trap, isn't it?
Scott: Exactly, and I think it's around, at the moment, I think it's around 60 days or, most small businesses, it's taking them two months to get the money in their accounts.
Darryl: To convert their service or product into actual cash in the bank.
Scott: Yeah, so just a quick example, if you ... Let's say your turnout is $360,000 a year so $1,000 for each day, we're just rounding to 360 days, and your accounts receivable's at 90,000. That means it's taking you 90 days to get your money.
Darryl: And if we go back to the first model, where we had the quadrant, there'd be a big clue in there, wouldn't there?
Scott: Yeah, and so if you're getting 90 and your terms are 30, then you've got a 60 day gap. And so if you're, so based on that, if you are able to reduce that down to, let's say 75, then you're going to put 15 grand back into your account. So it's $1,000 a day based on that.
Darryl: In just trying to recall in my memory, but I think Warren Buffet, one of the things he would always look at is the time that the cash took to actually resolve into the bank.
Scott: Yeah, he's a big, big believer in cash flow. Similarly, is inventory, and this is a big problem. We've seen it in climbs recently. If you've got too much stock then your cash is held up, and we've seen instances where people have 515 days with the cash. Let's say in our example of $360,000 in sales and it's costing him 180,000 in cogs or device at a 50% mark up, to let's say one and a half years that these people had-
Scott: So they had $270,000-
Darryl: Sitting in inventory.
Scott: Sitting in inventory, and so ...
Darryl: And worse thing, too, some of their inventory in that example was actually had a shelf life. So it was going to get to the point where if it wasn't moved within the shelf life period, then it was actually going to have no value.
Scott: And another trap that people fall into is they don't write it off because they don't want to make it look like they have a loss, so they don't write it off. Then they end up paying tax based on not writing it off. Because if they write that $20,000 off, then that's $6,000 in tax they're not paying on the company.
Darryl: Now, as you're listening to this, you'll be saying, yes I know that, and I know this, and I know that, and that's great. But what we're trying to show through our business acumen, it's a whole lot of things coming together. And that's the critical part about this process, isn't it?
Scott: Exactly. It's having a model or a checklist that you go through so you're not having to remember everything, because I can't remember everything. And lastly is accounts payable and sometimes businesses fall into the trap of paying things too quickly or before they're due. We always recommend people pay things when they're due, but if you don't have the right systems and you're paying things in advance, it's an effect on cash flow.
Darryl: And another discussion for another time is that we believe a lot in mental models and also rule of thumbs. And that way you're equipped to be able to quickly assess the situation and know, yes, we're heading in the right way, we're not, going to do an intervention, find out what's going on. Those are the things that can save a business.
Scott: Exactly. Especially with these, we have our dashboards with our rule of thumbs on it where it's green, orange, or red. And if it pops up, we need to go and look at something. So just quickly, let's have a look at price, when we're talking about strategic execution, when we're talking about price. Many businesses spend a lot of time getting their products or their services right, but they don't spend as much time on price. And so sometimes they just follow what the market is doing, so they might just mark it up because that's what the price is. Or they're not lining up their price with their strategy, so they're saying their strategy might be based on quality, but then they're pricing based on that their strategy is price. And so when it comes to price, you really need to, first thing you need to do is link it back to your strategy, and one of the main factors of your strategy is your customer value propositions.
So one of the tools that we use when we're dealing with strategy is the, from the business model canvas, and it's the ... I think they call it the customer value proposition canvas. And so it's a great tool for just working out what your customers value and then how that can relate back to price and your pricing structure. And so it's all about, like when we're talking about leave, is that doing that as 1% and making those little changes and ... There's a great story by Steven Levitt, you know the guy from Freakonomics? And he talks about when his consulting company were asked by a large fast food chain, he didn't say which one, and he had to go and look at price, because that's what his background is, is in price. What they noticed was at the chain or the franchises that had a lot, sold a lot of or a higher percentage of Happy Meals or the children's meals, people were less sensitive to price.
Darryl: Oh, interesting.
Scott: And so what they did was they increased price at those stores that were-
Darryl: On all of their products?
Scott: I don't know about all their products, but they increased probably because parents want to keep their kids ... Have a little bit of sanity while their kids play or whatever, so they increased price at those places. And just by doing that little bit, that increase, you know, I think it was like 30 million dollars to their bottom line just by doing little things. Obviously they have a larger scale compared to smaller businesses, but it's that thinking different and tying your customers' value back to your price.
Darryl: And then this doesn't necessarily have to be a huge deal, does it? It's really doing the business model canvas and understanding where your price points will be in terms of whether it be price, quality, etc etera. You can very quickly begin to zero on in a starting point, and now having the context of cash flow and how to go about strategic execution to get the right things happening, then the pieces start coming together, don't they?
Scott: Yeah, exactly.
Darryl: I liken it to the old railway switch yard. In the old days you used to have a person in the switch yard and they had a number of levers on which they could pull and they would direct the train traffic through the different switches to get them to their destination. It was a pretty critical role as you imagine, so I think of these as like the critical things in a business. You pull the right lever and you get a good result, the train gets to its destination on time, everybody's happy. Pull the wrong one at the wrong time, major disaster. So, that's the way I think of the seven levers.
Scott: Yeah, that's a great analogy, Darryl. So summing up, that's our seven levers to improve cash flow, but from a strategic execution point of view. It's just giving you a brief overview and again it's really, as we say that business acumen is the pay out to think differently.
Darryl: So what if people want to know more?
Scott: So if you want to know more, subscribe to our YouTube channel, there's a link just below. Or if you can link up to us on social media, we're on LinkedIn, Facebook, Twitter. If you're on YouTube, all the links are down below. If you're on our website, you can go to our contact page. We'd love to hear from you, especially on LinkedIn or if you have any questions please get in touch with us.
Darryl: Yeah, and we encourage you to go to our third video which now talks about the emotional intelligence and the critical nature of what that brings to business decision making.
Darryl: Thanks very much, Scott.
Scott: I thank you, Darryl.
Darryl: We'll catch you next time.