Where manufacturers' cash gets stuck: inventory, work in progress and customer terms

Manufacturers buy materials, pay a crew to turn them into product, store the product, ship it, and then wait to be paid. Every step ties up cash. A growing order book can make it worse: more jobs means more steel bought and more wages paid, weeks or months before the money comes back.

This article is part of our guide to the financial side of running a manufacturing business.

One number to watch: the cash conversion cycle

The cash conversion cycle measures how many days pass between paying for materials and getting paid by your customer:

Days of inventory (how long materials and product sit before being sold) + days to get paid (how long customers take) − days you take to pay your suppliers = days your cash is tied up

Your bookkeeping can give you all three from the balance sheet and income statement.

Example: a $6 million shop

A manufacturer of agricultural equipment parts near Wetaskiwin has $6 million in annual sales, and cost of goods sold is 70% of that.

That's $1.37 million of the owner's money (or the bank's) sitting in the shop and in customers' hands at any moment.

The levers, and what each is worth

Using the same shop:

None of these require a new loan.

Getting paid faster

• Invoice when the job ships, not at month-end.
• Take deposits and progress payments on custom work. On a $120,000 custom build, a 30% deposit is $36,000 you don't have to finance yourself, and it confirms the customer is serious.
• Agree milestone billing on long jobs: at engineering approval, at materials purchase, at completion.
• Watch the aged receivables report every week and call at day 30, not day 60.
• Check new customers' credit before extending 60-day terms on a large order.

Carrying less inventory

• Find the slow movers. An inventory report sorted by days on hand usually shows a small number of items holding a large share of the cash.
• Order to real demand. Minimum order quantities and "the price was good" purchases are where cash goes to sit.
• Shorten work in progress. Jobs that stall halfway (waiting for a part, a drawing approval or a customer decision) hold materials and labour.
• Deal with obsolete stock. It ties up space, insurance and attention. Selling it at a loss can be better than keeping it. See inventory that matches your books.

Paying suppliers on time, not early

Use the terms you're given. Paying a 30-day invoice on day 5 gives away 25 days of cash. The exception is a genuine early-payment discount: 2% for paying within 10 days instead of 30 is worth roughly 37% a year, and is usually worth taking.

Bank lines and borrowing bases

Many manufacturers have an operating line of credit tied to a borrowing base: the bank lends a percentage of your eligible receivables and inventory.

Example: what the bank will lend

(Percentages vary by bank and agreement.) Two things follow:

1. Accurate books directly affect how much you can borrow. Old receivables and unreconciled inventory reduce your borrowing base.
2. Banks usually want a monthly borrowing base report with aged receivables and an inventory listing, on time. We cover what lenders look for in reporting for owners and lenders.

Keep the tax money separate

The GST/HST you collect isn't working capital. Move it to a separate account as customers pay. The same goes for payroll source deductions. Late remittances bring penalties that hit faster than almost any other bill. If you import materials, GST paid at the border also affects cash flow; see imports, tariffs and GST at the border.

The bottom line

A manufacturer's cash problem is rarely about profit. It's usually about days. Measuring your cash conversion cycle every month, and working the three levers, can free up more cash than a new loan. If you'd like that report every month, along with receivables follow-up and a clean borrowing base, see how we help manufacturers.