The holy grail of distribution, as in every business, is sales growth. Increase your sales and you increase the bottom line.

But there's another, sometimes overlooked strategy to raising profit levels: Reducing the cash-to-cash cycle.

That's the amount of time, measured in days, between paying a supplier for an item and being paid for it by a customer.

Shaving a few days from this cycle adds directly to the bottom line because of the interest earned during those days on the money coming in from the sale.

When the economy is healthy and return on sales (ROS) can top 3 percent, such incremental savings might not seem like a big deal.

But when the economy is ailing and a distributor's ROS can fall to 1.33 percent or worse, saving several thousand dollars in interest can have the same bottom-line impact as increasing sales by millions of dollars.

As an example, say ABC Distribution does about $13 million a year in sales with that 1.33 percent ROS. That means for every dollar in sales, ABC realizes $1.33 in profits—not an unusual proposition when the economy is weak.

To add $26,000 to the bottom line, ABC would have to increase its annual sales by $2 million. Shaving 11 days from the cash-to-cash cycle, however, brings in that $26,000 without ABC having to make a single additional sale.

Here's the formula Mike Marks, managing partner at the Indian River Consulting Group, uses to calculate the cash-to-cash cycle:

(days cost of sales in inventory) + (days of sales in accounts receivable) – (days of purchases in accounts payable)

At our fictional business, ABC Distribution, days cost of sales in inventory (roughly speaking, that's how long it would take to empty your warehouse of inventory at current sales levels without adding additional stock) is 87.7 days; days sales in A/R is 47.8 days and days purchases in A/P is 36 days:

(87.7) + (47.8) – (36) = 99.5 days

Now compare that with another fictional firm, 123 Supply, which sells the same products in the same market as ABC but has a higher rate of inventory turns, lower A/R and higher A/P:

(80.4) + (44.8) – (37.1) = 88.1 days

The difference between ABC's and 123's cash-to-cash cycle, roughly 11 days, translates into $26,000 in savings (assuming an interest rate of 8 percent and working capital of $325,000). As noted above, that means ABC would have to increase sales by $2 million to get the same profit 123 realized by streamlining its cash-to-cash operations.

“Most of your typical distributors have working-capital-to-sales ratios of 0.25 to 1. This is why [reducing the cycle] makes so much difference: If I'm going to grow sales by $4 million this year, that means I need another million dollars in working capital. If I can get my cash-to-cash cycle shorter, maybe [my working-capital-to-sales ratio] is .125 to 1,” Marks explains.

It's one thing to understand why the cash-to-cash concept matters, but still another to effectively implement that knowledge.

Marks says there's a “cosmic rule” distributors should start with.

“You always take supplier discounts. If you want to make a lot of money, a distributor should take every cash discount that's offered unless the supplier is giving you dating terms,” he says. “If a supplier's offering you 1 percent on 10 days, you take it.”

And while suppliers typically offer terms of net 30 days, some will favor their better distributors with more attractive terms. Taking cash discounts is a good start to maintaining the good graces of suppliers, Marks notes.

“Some suppliers may go to their good distributors and say, 'If you're a “Gold” distributor of ours, our terms are net 45 days,'” he says. “For the distributor, that takes 15 days out of the cycle.”

That said, inventory is the first thing distributors should examine when seeking to shorten their cash cycle, Marks says. Resisting the siren song posed by bulk discounts is the first step, he adds.

“The number one thing that messes up inventory turns for people is excess inventory,” Marks notes. “The old mentality is, 'If I buy a lot, I can get an extra 5 percent discount.' It's like an airplane trading altitude for speed. The way to make an airplane go faster is to point it towards the ground, but there's a point of diminishing returns.”

That's because when a customer needs only 100 items, but the manufacturer offers a discount if you buy 1,000, those extra 900 items sit in your warehouse gathering dust, adding to days cost of sales in inventory and increasing the length of your cash cycle.

Supplier minimums pose a similar threat, Marks notes, adding that buying from a master distributor or even a competitor can short-circuit that risk.

“It's counterintuitive, but you're going to get much better inventory turns and have a much stronger balance sheet [if you] buy from a competing distributor, even if you don't make any margin on it,” he advises. “Buying from a master [distributor] is another way to do it. Most distributors would make a whole lot more money if they bought from master distributors.”

But Paula Bass, president of Detroit-based KBC Tools & Machinery Inc., notes that lean inventory isn't always practical.

“Especially if you're an importer, somebody has to hold the inventory. The 'just-in-time' concept of business is great, but somebody has to have [the item] so you can get it in time for a customer,” Bass says. “You can use UPS air overnight, but if you're bringing in something from China, it's not coming in overnight. Overnight [in that case] is like two, three, four days.”

Another tactic Marks proposes also runs against the grain of conventional wisdom: Paying freight charges. Manufacturers will often pay to ship an order if it meets certain minimum criteria, an offer that's difficult for most distributors to pass up.

“Distributors genetically don't like to pay freight,” Marks notes. “They end up carrying excess inventory to avoid the freight costs and a lot of that's pretty silly. A distributor could actually reduce their freight costs a lot by paying freight on some of these [special and minimum orders]. What they end up doing is significantly improving their turns.”

That's because ordering smaller quantities more frequently increases the rate of inventory turnover, which directly reduces the number of days in the cash-to-cash cycle. And with modern software packages designed for distribution, weighing the benefit of higher fill rates against freight costs is made easy, Marks says.

“Most people don't even do the math, but most of the software packages these guys have will do the math for them. Instead of having eight turns they can have six turns, and for a lot of these guys that's five or six days [pared from the cash cycle].”

Bass cautions that paying freight for small orders is a balancing act that may not pay dividends for every distributor. For her volume-based catalog business, paying freight charges can be an exercise in reducing profit margins.

“Freight can end up being 25 percent of the cost [of an item],” Bass notes, adding that especially with heavy machinery orders, “that can kill your margins.”

“It can be helpful if you have few of those [type of orders] and it helps keep your inventory down, but if you get to too many of those you just don't have any profit margin,” she says. “You have to decide what kind of business you're in. Are you a service business or a low-cost provider?”

The lag between delivering an item to a customer and being paid for it is a perpetual problem for many distributors. While typical terms are net 30 days, INDUSTRIAL DISTRIBUTION's 61st Annual Survey of Distributor Operations (see page 24) shows that the average distributor's accounts receivable time runs to 42 days.

Closing that gap between your stated terms and your actual accounts receivable time is a good way to reduce the cash cycle, but it's often easier said than done.

One common problem involves special or last-minute orders in which the usual paper trail is disrupted, according to Abe WalkingBear Sanchez, a business consultant who specializes in credit issues.

“Seventy-three percent of all past due [invoices] are tied to something going wrong somewhere [in the paper trail],” Sanchez says.

To avoid that, he advises getting to know how each of your customers processes invoices and tailoring your operation to work in sync with theirs.

“Track the source of these things that have gone wrong,” Sanchez says. “The end result is you drive down the cost of your doing business and, surprise surprise, you drive down your customers' cost of doing business.”

“Customers will hold up an invoice while these things are worked out. They'll pay once the paperwork is right,” Marks notes, adding that the typical Industrial Supply Assn. distributor could shave five days in A/R and days sales outstanding from their cash cycle by gaining a better understanding of how their customers operate.

KBC Tools' Bass looks to establish the ground rules early on with new customers, using their credit application to glean contact information and job titles that might be invaluable down the road.

“It's always easier to work with your newer clients than your older clients and train people from the beginning. For newer clients, we try hard to let them know what our terms are in the beginning, to reiterate those terms and to make friendly [collection] calls early,” Bass notes.

With a volume-based operation, she says, it's impossible to get to know every one of her company's myriad customers, let alone decipher the ins and outs of their business.

“The fact is, we have thousands of clients at every one of our facilities,” Bass says. “You can't afford to know the details of each client. … Although we have clients we've dealt with for over 45 years, we may never have met them.”

That's why KBC focuses on getting as much information as possible from the outset of a relationship with a new customer and looks to educate that customer about KBC's terms.

“We've learned a lot over the years about what information we need, so we try to get it at the beginning,” she says.

For those customers who, despite your best efforts to learn their business, still wind up past due, Marks and Sanchez agree: Avoid using your credit department as a collection agency.

“Once they become past due, the way you reduce your turn time is early contact. In a business you're not dealing with debtors, you're dealing with customers. Most past due [accounts] are not trying to avoid payment. The job is really completion of the sale,” Sanchez says.

To that end, both Marks and Sanchez advise having your sales force involved in collecting past-due invoices.

“Sales guys are the best guys to be working past due accounts. They have the relationship, they have the skills, they have the attitude,” Sanchez says. “You've got to find out how these guys do business.”

“The sales guy is the closest one to getting the answer,” adds Marks. “There are several days of sales that you could collect faster if salespeople were involved in processing credits and sales purchases.”

Bass' advice to fellow distributors looking to cut down on their cash cycle is simple.

“Put people on hold. Be tough. You can always bend rules, you can always work with people, but if you just let people keep going and going and going they have no incentive to pay you,” she says.

“My goal is [that] the only calls I get are from clients who want to place orders, that we don't receive any calls from suppliers for payables and we don't have to call any customers for payment. Then we can focus on selling. That would be my perfect world.”