A New Language

I

magine an environment in which key employees in all kinds of jobs learn to use a simple, cash-focused vocabulary as the primary way of framing business issues and taking part in business discussions. Imagine the improvement in clarity of

Business doesn’t run

on profit; it runs on

cash. Business doesn’t

run on sales growth; it

runs on cash. Business

doesn’t run on even

the best and most

realistic prospects for

the future unless the

immediate future

contains enough cash

to pay your bills.

communications. Imagine the sharpened focus on measurable goals. Imagine the improvement in cash flow and, ultimately, company value. The benefits cross all boundaries. Large firms and small ones, without regard to

location, division or product specialty, would benefit. Imagine the possibili- ties in your company, on your job, if the effects of not only the big decisions but also the relatively ordinary ones were routinely processed through a cash-flow mindset and discussed in common terms. This language con- sists of the dynamic vocabulary of the seven cash drivers (that I’ll detail in Chapters 5 through 11) operating within a basic accounting grammar

that I will cover in Chapters 3 and 4. With the background of our basic cash-flow discussions thus far, let’s turn to an overview of the cash drivers.

CASH DRIVER #1: SALES GROWTH. The most basic cash driver is the sales-growth rate—typically measured as the percentage change in sale volume from the previous period. Sales growth is one of the first things that lenders, managers and professional financial analysts look at when evaluating business perfor- mance. The reason is straightforward: Sales volume tends to drive practically everything else. Other things being equal, sig- nificant changes in sales volume will have major ripple effects through the company’s balance sheet, income statement and, especially, its cash-flow statement.

CASH DRIVER #2: GROSS MARGIN. Gross margin is what remains from sales after you have covered your direct product or ser- vice costs. Gross margin is measured and expressed as a per- cent of sales to help demonstrate more clearly how many cents out of each sales dollar are available to pay for everything else in the business. All operating, financing and tax costs as well as any return to owners of the business will come out of the gross margin.

Imagine the possibilities

in your company, on your

job, if the effects of not

only the big decisions,

but also the relatively

ordinary ones were

routinely processed

through a cash-flow

mind-set and discussed

in common terms.

CASH DRIVER #3: SELLING, GENERAL & ADMINISTRATIVE EXPENSE (SG&A).This is commonly thought of as your overhead in man- ufacturing and merchandising businesses. In a service business, where there is often no gross margin per se, SG&A also includes those costs associated with providing the service that is your reason for being. SG&A is generally best expressed as a percent of sales to reveal directly how many cents out of each sales dollar are taken by normal operating expenses.

CASH DRIVERS #4, 5 AND 6: ACCOUNTS RECEIVABLE, ACCOUNTS PAYABLE, AND INVENTORY. Rather than thinking about each of these items as a percentage of sales, as with the preceding dri- vers, we normally find it most helpful to think about these trading accounts in relation to time. The term is days’ worth—

so many days’ worth of annual sales tied up in accounts receivable from your customers, so many days’ worth of annual cost of goods sold expenses tied up in your inventory investment, so many days’ worth of annual cost of goods sold financed by your suppliers through accounts payable. These days measures also have the benefit of simultaneously telling how long it typically takes for three important things to hap- pen: How long it takes to collect on a sale (accounts-receivable days), how long the average item sits in inventory before sale (inventory days) and how long we typically have benefit of a supplier’s product or service before actually paying for it (accounts-payable days).

CASH DRIVER #7: CAPITAL EXPENDITURES. What does it take in the way of new investment in the infrastructure of your business to keep it healthy and growing? That’s the capital expenditures (Capex) issue. It is usually helpful to measure this cash driver both in absolute terms—that is, in dollars—and also in relative terms linking it to sales growth. The best relative measure I have found is capital-expenditure dollars expressed as a per- cent of the dollar growth in sales during the same period. It takes more in the way of fixed assets to support higher levels of sales, and so we want to express that reality in a relational way.

If somehow we could know the relative levels of the seven cash drivers for any good sample of companies, say the

Fortune 500, for the coming year, we could predict with amaz- ing accuracy their likely levels of cash flow. Although there are lots of other factors besides these seven, these are the drivers,and they are the drivers because imbedded

within them are the core issues and rela- tionships of the enterprise. As we focus on each of the drivers in their individual chapters, we will look specifically at what those issues are.

The cash drivers apply not just to large companies but to allorganizations, especially businesses, of virtually any size. In the small enterprise with a handful of employees and sales of up to a few million dollars, the draw that the

owners take may reasonably be considered an eighth cash dri- ver. That account can vary significantly and, in a sense, rep- resents a special subcategory of SG&A expense. We won’t be dealing with this element specifically, but keep it in mind if your situation makes it appropriate.

Some specialized industries may also have their own key measures that can effectively be used as cash drivers—for example, percentage of seats sold (load factor) for an airline, or percentage of homes penetrated on a line for a cable-TV operator. For most of us most of the time, however, the basic seven cash drivers are the appropriate tools. Let’s take a mini case study to illustrate some of the areas in which cash-driver language can make business smoother and simpler.