Managing cash: What a

difference the days make!

John W. Mullins
Associate Professor of Management Practice, London
Business School ([email protected])

Neil C. Churchill
A s the business cycle finally takes a long-awaited
turn upward, the attention of managers is turn-
ing from controlling costs to managing growth.
Among the most critical tasks faced by those who run
growing companies is managing cash. The problem entre-
Visiting Professor, Anderson School of Management, UCLA, preneurs and managers face is that, as revenues grow, so
and Professor Emeritus of Entrepreneurship and Family too must working capital, organizational capabilities, and
Enterprise, INSEAD, Fontainebleau, France fixed assets grow to support the increasing sales. To put it
simply, growth takes cash.
Surprisingly, however, when we asked a sample of entre-
preneurs who lead rapidly growing companies what they
do on a regular basis to track the drivers of their cash for
growth, we found their attention focused more on in-
come statement measures, including revenue and gross
margin, than on the balance sheet, where important
sources and uses of cash also reside. The problem here, of
course, is that the cash consumed by growth in working
These days, entrepreneurs capital and other assets appears nowhere on the firm’s
income statement. In fact, a rapidly growing company can
and managers in growing consume so much cash for working capital and other
assets that even a minor level of mismanagement of its
companies find themselves cash can cause the firm to run out of funds and find
itself—suddenly and unexpectedly—in bankruptcy.
searching for cash to fund their
In our earlier work (Churchill and Mullins 2001), we
growth. A surprisingly good but developed a framework that managers of growing firms
often neglected place to look for it lies can use to figure out just how fast their companies can
right under their noses—on the company’s grow from internally generated sources without running
out of cash. Here, we turn our attention to a different
balance sheet! Finding hidden cash on one’s
question: Why do entrepreneurs and managers of high-
balance sheet by using the simple analyses growth companies give their balance sheets short shrift in
described in this article sure beats going hat-in- managing their cash? In part, we find, it is because general
hand to the bank. And the analyses also provide managers often view the diagnostic tools that bankers and
accountants recommend—like the current ratio (current
metrics that everyone in the company, from sales
assets divided by current liabilities), the quick ratio (cur-
manager to accounting clerk, can understand rent assets minus inventory, all divided by current liabili-
and use. Best of all, the only things you’ll need ties), and the acid test (current assets minus inventory
are last month’s financials, a calculator, and a minus accounts receivable, all divided by current liabili-
ties)—as arcane or confusing, nonintuitive, and not nearly
cocktail napkin.
as attention-grabbing as income statement accounts such
as sales or profit. As a result, such ratios get scant atten-

Business Horizons 47/6 November-December 2004 (79-82) (Article accepted under the editorship of Dennis W. Organ) 79
 J. Mullins & N. Churchill / Managing cash: What a difference the days make!

turing and distribution companies; or unbilled serv-

Figure 1 ices for work already performed but not yet invoiced
Chullins Company financial statements (000s) for service firms)
Income statement How is an entrepreneur or the general manager of a
Daily rate high-growth firm to know whether the amounts in
Sales $2,000 100% $5,479 these balance sheet accounts are too high, too low,
Cost of sales 1,200 60% $3,288 or about right? Conventional banker thinking sug-
Gross profit 800 40% gests that the conventional ratios can be calculated
Operating expense 700 35% to assess the current levels of working capital overall
Net profit after tax 100 5%
and any changes therein. Instead of thinking in ratio
terms, however, we suggest that entrepreneurs and
Balance sheet
Dollars Cash-days high-growth general managers calculate a cash-days
Cash $ 10 analysis each month to assess whether the com-
Accounts receivable 384 70 pany’s working capital accounts are in good shape.
Inventory 263 80 We use this phrase to indicate that any changes in
Total current assets 657 the number of days can either provide or consume
Plant & equipment 25 cash that can be used for growth. A cash-days analy-
Total assets 682 sis can be done on a cocktail napkin in a matter of a
few minutes. Here’s how to do it.
Accounts payable 99 30
Bank loan payable 50 Accounts receivable
Total current liabilities 149
Owners’ equity What determines the level of accounts receivable?
Contributed capital 350 There are two drivers: the pace at which the com-
Retained earnings 183 pany generates revenues, and the speed at which
Total owners’ equity 533 customers pay. To calculate the cash-days of ac-
Total equities 682 counts receivable, one simply figures the daily rate
of sales for any available time period—in our hypo-
thetical Chullins Company, shown in Figure 1,
tion—far less than cash management deserves. In this that’s $2,000,000 divided by 365 days, or $5,479
short article, we offer a solution to this common problem. per day. (A similar calculation could be made using 91
days for quarterly or 30 days for monthly periods of sales
What might entrepreneurs and others who lead high- data, if available.) Then divide the accounts receivable bal-
growth firms do to better understand their balance sheets ance by the daily rate of sales to calculate the cash-days
and thereby better manage their cash? We suggest two ($384,000 / $5,479 = 70 cash-days). Just round the cash-
simple analyses, each undertaken monthly, designed to days figure to a whole number, which is more manageri-
aid cash management and to determine where cash for ally useful in most companies.
growth might be found—on the company’s own balance
sheet rather than at the bank. We call these the cash-days Accounts payable and inventory
analysis and the hidden cash analysis. What determines the level of accounts payable or inven-
tory? Again, there are two drivers: the cost of producing
goods or services that are sold, and the speed at which the
Cash-days analysis bills are paid (for accounts payable cash-days) or inventory
is used (inventory cash-days). To determine the cash-days

A
cash-days analysis (either historically or industry- for either account, first calculate the daily rate for cost of
comparative) assesses a company’s working capi- sales for any available time period; again, for Chullins,
tal accounts. In most companies, working capital that’s $1,200,000 divided by 365 days, or $3,288 per day.
consists largely of three items: (Once again, a similar calculation could be made using
1. accounts receivable (what your customers owe you for quarterly or monthly periods.) Then, for accounts payable,
what you’ve sold them) divide the accounts payable balance by the average daily
cost of sales to calculate the cash-days ($99,000 / $3,288 =
2. accounts payable (what you owe your suppliers for 30 cash-days). For inventory, divide the inventory balance
what you’ve bought but not yet paid for) by the average daily cost of sales to calculate the cash-days
3. inventory to support tomorrow’s sales (materials, work- ($263,000 / $3,288 = 80 cash-days). Service firms would
in-process, and finished goods on hand for manufac- employ similar logic to determine their cash-days for un-
billed services, their equivalent to work-in-process and fin-

80 Business Horizons 47/6 November-December 2004 (79-82)

J. Mullins & N. Churchill / Managing cash: What a difference the days make!

ished goods inventory. (We assume Chullins is in the dis- Suppose Chullins needs cash to finance an effort to grow—
tribution business, so that only purchased material costs perhaps for new production capacity, an advertising cam-
are involved in its cost of sales and accounts payable. If it paign, to strengthen or extend its intellectual property, or
were a manufacturer, only the materials portion of cost of to hire a new salesperson. The cash-days analysis taken
sales would be used in the cash-days for accounts payable, one step further to what we call a hidden cash analysis can
while both purchased materials and labor costs would be
used in its cost of sales and cash-days for inventory.)
In many businesses, other working capital accounts may
be important, such as prepaid media outlays in the adver-
tising or direct marketing businesses. Where this is the
Going hat-in-hand to the bank
case, the simple logic described above leads to similar is not always the most pleasant
cash-days calculations for these accounts. Once the analy-
sis has been generated, the entrepreneur should ask two or productive way to address the
sets of questions.
● How do this month’s cash-days compare with those in
challenge of finding cash for
prior months, or to our goals? Are accounts receivable growth.
too long (too many days) because some customers
have not paid? Instantly, calls to overdue and nearly
overdue accounts can be made to rectify this problem,
and goals (established in number of cash-days) can be sometimes uncover, on the company’s own balance sheet,
set so those responsible for collecting receivables can cash that can be used more productively.
take preventive action in the future. Examining the
Consider Figure 1 again. Chullins’s cash-days for accounts
order processing, fulfillment, and billing processes
receivable stand at 70. What if, by getting invoices out
from receipt of the order to mailing the invoice can
more quickly or through more careful follow-up with cus-
often save several “days” that were wasted by inefficient
tomers to collect receivables within their terms (or by set-
clerical, production, and management processes.
ting tighter terms), the average cash-days could be reduced
● How do our cash-days compare with those for others to 60? Doing so would lower the balance in the accounts
in our industry? Industry-average income statements receivable account by one-seventh (10 cash-days divided
and balance sheets, from which industry-average cash- by 70), or from $384,000 to $329,143. Effectively, such a
days can be calculated, are available for virtually any change in working capital management would uncover
kind of business from a variety of sources, including almost $55,000 in hidden cash on the company’s own
the Risk Management Association’s Annual Statement balance sheet! Once such a change was implemented, this
Studies, available on the Internet (at www.rmahq.com) amount of cash would appear—almost magically—in
or in most business libraries. Chullins’s cash account.
Thinking in terms of cash-days, rather than in terms of Next, let’s look at accounts payable. What if Chullins
ratios, is powerful for two reasons. First, it is so intuitive. could convince its suppliers to allow it to pay its bills just
Anyone in the company—from the top salesperson to the a bit more slowly, in return for faster growth, which
accounts receivable clerk hired yesterday—knows what would provide more business for them? Let’s say payables
you mean when you say that accounts receivable need to could be stretched from the present 30 cash-days to 40, an
be at, say, 60 days or less at each month-end, no ifs, ands, increase of one-third (10 cash-days divided by 30). How
or buts! The same holds true for those responsible for much cash would such a change free up? At 40 days in-
managing inventory and accounts payable. The second stead of 30, the payables balance would be $132,000
way the days make such a difference is in finding hidden instead of $99,000, thus releasing another $33,000 in
cash for growth. hidden cash!
What about inventory? If inventory could be managed a
bit better—say, 75 cash-days on average instead of 80—the
Hidden cash analysis one-sixteenth reduction in inventory (5 cash-days divided
by 80) would bring inventory down to $246,563, thereby

F
inding cash for growth is an important challenge in uncovering another $16,437 in hidden cash. Thus, in total,
growing companies. Going hat-in-hand to the bank Chullins could unlock more than $100,000 in hidden cash
is not always the most pleasant or productive way to by making these modest changes in how it manages its
address this challenge. Once again, let’s think in terms of cash-days of working capital. The good news is that none
cash-days. of these changes is likely to have any material impact on

Business Horizons 47/6 November-December 2004 (79-82) 81

 J. Mullins & N. Churchill / Managing cash: What a difference the days make!

the company’s sales or profitability, as long as customers look at their responsibilities in terms of cash-days, and
and suppliers are willing to accommodate them. ask your controller to do a cash-days analysis and a hid-
den cash analysis this month and every month—or do
them yourself on a cocktail napkin. Then watch your

T hinking about your company’s working capital,

order processing, fulfillment, billing, and inven-
tory management systems in terms of cash-days
can have a powerful impact, not only to protect your firm
from running out of cash but also to find hidden cash to
company grow, without running out of cash. ❍

References and selected bibliography

Churchill, Neil C., and John W. Mullins. 2001. How fast can
support your growth, without that trip to the bank. Best
your company afford to grow? Harvard Business Review 22/5
of all, the cash-days logic provides metrics that everyone (May): 135-144.
in the company can understand. Ask all your managers to

82 Business Horizons 47/6 November-December 2004 (79-82)