The ultimate guide to cash flow for craft breweries (part 2)

Yesterday, we posted part 1 of the Ultimate Guide to Cash Flow for Craft Breweries by Kary Shumway. In part 1, Shumway explains the Cash Flow System. Below, are specific examples of how the Cash Flow System can be implemented in your company. The system is used with each cash flow driver to measure, manage and improve the number.

Cash flow driver No. 1: accounts receivable (A/R)

Accounts receivable are your uncollected sales. You’ve made the beer, delivered it to the distributor or retailer, and now you need to collect the cash. Many states have credit laws which require retailers to pay you within a certain time period. For example, Vermont is a cash-on-delivery state, while New Hampshire gives retailers 15 days to pay. In New Hampshire, if the retailer doesn’t pay in the required time frame they are put on a “list” and are unable to purchase beer from any other distributor until the invoice is paid. I always liked that rule.

Keeping on top of your A/R is a critical piece to increasing cash flow. A first step is to determine if you are collecting the money fast enough — the Days Sales Outstanding (DSO) calculation is a helpful measurement. The DSO calculation works like this: take your average daily sales and divide it into your accounts receivable. For example, if sales were $3,000,000 in June, a month with 30 days, your average daily sales are $100,000.

If your A/R balance is $2,000,000, divide this by $100,000 average daily sales and the result is 20 Days Sales Outstanding. There are lots of variations on this calculation (you can use selling days instead of calendar days), but the key is to be consistent with the calculation.

Action items to master your accounts receivable:

1. Calculate your current Days Sales Outstanding in A/R, compare it against industry benchmarks, and set a goal to improve.
2. Communicate the goal to everyone who can make an impact on improving the number – the sales team, drivers, merchandisers if appropriate. It takes a village to collect the money. Engage the villagers.
3. Establish a regular routine to monitor the progress towards the goal. Creating a Brewery Financial Scorecard is a good start — a daily email from your credit manager or finance person with the DSO calculation helps to keep on top of the number.
4. Hire the right person. Many people do not like to collect money, but a select few love it. Find those people, get them into the collection role, and turn them loose.

Cash flow driver No. 2: inventory

Inventory is the life blood of your brewery, but if not managed properly it will suck the life out of your cash flow. A typical brewery will spend hundreds of thousands of dollars a year on raw materials and packaging. There are so many brands and SKUs to manage, it’s easy to lose track of your inventory numbers and how much you have on hand. Seasonal products, line extensions and the myriad package sizes have contributed to the infamous SKU proliferation. Keeping on top of your inventory value has never been more important.

Inventory Days on Hand (DOH) is a helpful metric to calculate whether inventory is eating up too much of your cash flow. The measurement can be applied to your inventory as a whole, or to individual suppliers, brands and packages to identify where you’re running heavy. The calculation works like this: Take your average daily cost of sales, and divide it into your inventory balance. If your cost of sales is $2,250,000 in June, a 30-day month, your average daily cost of sales is $75,000 (trust me, I did the math). If your inventory value is $3,000,000, divide this by $75,000 and the result is 40 Days on Hand. That’s a lot of cash sitting in inventory.

Action items to master your inventory:

1. Calculate your Days on Hand, compare it to industry benchmarks, set a goal to improve.
2. Communicate the goal to your team — anyone who can make a difference. Usually this is the inventory manager, the general manager, and the sales team.
3. Establish a regular routine to monitor your Days on Hand and progress toward your goal. This is another good metric to put on your Daily Numbers.
4. Walk the warehouse. Reports are one thing, but seeing the inventory (the money) sitting in the brewery will make a difference. Talk to your people, ask questions. What problems do they see? Are there brands that just aren’t moving? Are there packages that are more susceptible to breakage? Get their input. The answers may surprise you.

Vessel hygiene: Microbial monitoring and detection methods for brewing equipment. Just click!

Cash flow driver No. 3: accounts payable (A/P)

Accounts payable are your unpaid invoices. You’ve ordered inventory, received it and now you need to pay out the cash. From a cash perspective, accounts payable is “money out,” while accounts receivable is known as “money in.” Managing your money out is as important, if not more important, than watching the money coming in.

At a typical brewery, the purchasing process involves a lot of people and paperwork. There is an approval process that must be followed to ensure expenses are authorized before cash gets paid out. Purchase orders are created, products or services are received, and invoices are reviewed and approved to be paid. The invoice then goes to the accounts payable department for payment.

The accounts payable team is the last line of defense before an invoice is processed and paid. It’s their job to make sure all the proper approvals are in place and the paperwork matches up properly. Millions of dollars flow through your A/P department each year, so it’s critical to cash flow to carefully manage and monitor your “money out” process. Keeping on top of your A/P is a critical piece to mastering your cash flow. A first step is to determine if you are paying your invoices too quickly — the Average Days to Pay calculation is a useful measurement.

The Average Days to Pay calculation works like this: take your average A/P balance for the month (beginning of month A/P + end of month A/P divided by two) and multiply by the number of days in that month. Then divide this by the total purchases for the month. For example, let’s say you had average A/P of $1,200,000 in the month of June, and total purchases of $1,500,000. You’d multiply the A/P by 30 days, and then divide the result by the total of your purchases: $36,000,000 divided by $1,500,000 equals 24. This means you’re paying your bills on average in 24 days.

On its own, this number doesn’t mean much. You’ll need to look at your vendor terms and determine if you’re paying too quickly. If most of your vendors give you 30-day terms, then in the example above, you’re paying too quickly and paying out cash before you need to. Lots of things can influence this number (paying bills early to take early pay discounts, certain vendors who require COD payment, etc) but this can be a useful benchmark to determine how well you are managing your cash flow related to your A/P. Where cash flow is concerned, the higher the number of Average Days to Pay, the better.

Action items to manage your accounts payable:

1. Calculate your Average Days to Pay — how many days you take on average to pay your invoices
2. Compare your Days to Pay against industry averages; are you paying “too quickly?”
3. Review your supplier and vendor payment terms — do your vendors give you 30 days to pay, but you’re paying in 20? Side note: Always take early pay discounts. Vendors may offer a 1% or 2% discount if paid within 10 days. You’ll sacrifice short term cash flow, but the ROI can be an annualized 36%, you won’t find a better return on investment.
4. Set a goal to improve your Average Days to Pay, and communicate to your team. The A/P manager will have the most control over this number as they are the last line of defense before the cash is paid out.
5. Examine your invoice approval and payment process. Who can approve a payment? Are they really looking at what money goes out?
6. Personally review every invoice that gets paid. Take one week and personally write the check for every invoice that is due to be paid. You will be amazed at the stuff you’re paying for. Too often, we just approve invoices, pay them, and move on to the next one. If you take the time to sit with each invoice you’ll find many expenses you never even knew you were paying for.

Cash flow driver No. 4: capital expenses (CAPEX)

Capital expenses are those big ticket purchases: new tanks, forklifts, brewery improvements, etc. These are purchases that have a large dollar amount (over $5,000 for example) and a useful life of more than one year. CAPEX are recorded as assets which live on the balance sheet. A portion of these items get expensed or depreciated each year over their useful life. The idea is to spread the cost of the purchase over the useful life of the asset.

For example, a forklift may cost you $35,000 and have a useful life of seven years (as defined by the IRS). You’ll pay the cash today, assuming you don’t finance or lease the purchase, but you won’t expense the item until it is depreciated. The cash is gone, but the expense isn’t recorded on the income statement until depreciation is recorded.

The brewery business is very capital intensive — lots of stainless steel and equipment. Delivery trucks need to be replaced on a schedule, new laptops and IT equipment needs to be purchased, and the brewery regularly needs improvements. All of these purchases are necessary to keep up with growth, but they also suck up cash. Keeping on top of your CAPEX is a critical piece to mastering your cash flow (this should sound familiar by now). A first step is to determine how efficiently you are using your assets. The Return on Assets calculation is a useful measurement – it reveals what your company can do with what it has.

The calculation works like this: Return on Assets = Net Income divided by Total Assets. Simple enough, right? For example, if your Net Income is $1,000,000 and your Total Assets are $10,000,000, you have a 10% Return on Assets.

Action items to manage your capital expenses:

1. Calculate your Return on Assets
2. Compare your company’s number to the industry average
3. Create a capital budget. Plan when you’ll make purchases and determine the impact on cash flow. Review the Return on Assets calculation with your team as you plan the capital budget.
4. Set up an equipment line of credit with your bank. Negotiate a good interest rate and have the dry powder available to purchase trucks, equipment and other Capex when you need it. If you need to pull the trigger on a big-ticket item, financing will help match the cash flow out more closely to the depreciation expense.
5. Lease vs. Buy. Look at options for leasing instead of purchasing an asset. Leasing can take the stress off of cash flow, and leverage the expertise of a leasing company. We are in the beer business; they are in the leasing business, take advantage of what these vendors have to offer.

Creative equipment choices: Learn to buy a beer foeder with Schlafly Founding Brewer Stephen Hale.

Cash flow driver No. 5: operating performance (profit)

We reviewed earlier that profit and cash flow are not the same — a dollar of profit does not mean you received a dollar of cash. That dollar can be hung up in accounts receivable waiting to be collected, sitting in warehouse inventory, or stuck in your capital expense. However, the two are related, and profit has a big impact on cash flow. To improve your profit, you’ll start with the components that make up the bottom line: sales, margin, and operating expenses. Sales minus the cost of sales (purchases, freight, taxes) equals margin. Margin minus operating expenses equals your profit.

The key is to start with the bottom line first. Identify what you need for profit, and work backward from there. As simple as this concept is, it’s very effective. When you begin with the end in mind, you can create a Profit Plan that is designed to achieve your most important goal: Profit. As one of the five Cash Flow Drivers, when you increase profit, you increase cash flow. Everyone wins. As with the other cash flow drivers, it is helpful to create metrics to manage your sales, margins and operating expenses. Percentages work well here, as you’ll only need to focus on three or four numbers to understand where you stand in relation to the plan. Below is an example:

Profit plan:

$ Sales forecasted at 3.5 percent growth over prior year
$ Margin 40 percent of sales
$ Operating expense 30 percent of sales
$ Profit 10 percent of sales

With a summary profit plan using percentages, you only need to look at these four numbers to see how you’re doing (instead of the dozens of pages and line items on your financial reports). Really, you only need to look at the profit percentage. Begin with the end in mind.

1. Action items to manage operating performance:
2. Build a profit plan: start with your profit goal, and work backwards from there.
3. Create your sales forecast, margin plan, and operating expense goals. All of these will support your profit goal.
4. Publish the plan numbers. Share them widely. Educate your teams on what the numbers mean, how they can improve them.

Hold regular weekly meetings to review actual results compared to the plan. Use these meetings as an opportunity to train and educate your team on how the financials work, and how they can make a big difference in achieving the profit goal.

Cash is king

There is a difference between profit and cash flow. Understanding this is the first step to improving, and eventually mastering cash flow in your brewery. Along with profit, accounts receivable, accounts payable, inventory and capital expenditures have a big impact on your cash flow, and need to be closely monitored and managed. This guide presents specific, actionable steps you can implement in your brewery today to improve cash flow and put more dollars in the bank.

Know the 10 laws of business, recognize the difference between profit and cash flow, learn five drivers of cash flow, and implement the cash flow system. Now you have the knowledge and the tools. Get out there, take action, and master the art of cash flow in your business.

Kary Shumway is the founder of Beer Business Finance, an online resource for beer industry professionals. Shumway has worked in the beer industry for more than 20 years as a Certified Public Accountant and currently as chief financial officer for Clarke Distributors Inc. in Keene, N.H. Beer Business Finance publishes a weekly beer industry finance newsletter, offers guide books on topics such as sales compensation planning, SKU management and financial literacy and produces a weekly podcast. The newsletter with a free six-month trial, industry guides and podcast are all available at www.BeerBusinessFinance.com.