When “Harmless” Decisions Destroy Cash

• Author: Reginald Tomas Lee
• Date: 01 November 2013
• Published date: 01 November 2013
• DOI: http://doi.org/10.1002/jcaf.21903

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© 2013 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.21903

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Reginald Tomas Lee

INTRODUCTION

Companies of all

sorts have one thing in

common. They must

create cash. Whether

they’re publicly traded,

privately owned, or

even nonprofit, the

absence of cash means

the company may not

be able to meet their

ultimate mission of pro-

viding communications devices,

janitorial services, or providing

money for medical research.

Therefore, cash-generating tech-

niques should be second nature

and a main component for deci-

sions that are made. At a very

minimum, that which creates

and consumes cash should be

clear and understood.

The problem is that they

aren’t. The following examples

are based on real, personal expe-

riences with executives. These

are competent, conscientious,

and educated business leaders.

They are not out to sabotage

their organization or its results.

Yet the decisions that they made

or considered making would

destroy cash.

All companies must create cash. So what cre-

ates or destroys cash should be clear and

understood. But the problem is that they aren’t,

explains the author of this article—who gives

examples based on his work as a business

consultant. Competent and conscientious busi-

ness leaders can still make “harmless” decisions

that destroy cash. Here’s how to avoid that.

© 2013 Wiley Periodicals, Inc.

When “Harmless” Decisions

Destroy Cash

WORKING CAPITAL EQUATIONS

ARE WRONG

The senior vice president

of a manufacturing company

mentioned in a conversation that

if he could reduce inventory by

$10 million, his cash position

would improve by $10 million.

His assumption was that inven-

tory is really the same as cash.

The Mistake

Inventory is included in

working capital equations as if

it were cash, but it isn’t. Unlike

payables and receivables, the

cash dynamics behind creat-

ing inventory suggest that in

both creating it and disposing

of it, they do not work on a

one-to-one basis. For

instance, consider

selling $1 of inven-

tory. If sold at $2,

it generates $1 in

taxable profit. At

30%, this is down to

$0.70. When reduc-

ing inventory on

hand, many factors

come into play: gross

margin, tax rate, and

disposition method.1

DOING MORE COSTS MORE,

NOT LESS

A large company wants to

compete with its smaller com-

petition. The company decides

it cannot compete with smaller

companies with smaller over-

head structures. They decide

that to win business, they have

to produce in excess of demand

to lower their unit cost. They

win the business and waste cash

building inventory they don’t

need and will never sell.

The Mistake

Cash savings calculated

by cost-per-unit metrics are a