Analyze Your Customer Line to
Improve Profitability and Cash Flow

It’s no secret that inventory is a large percentage of a manufacturer or distributor’s balance sheet. It’s also no secret that a major success indicator is high sales. The challenge facing these types of companies is turning inventory and high sales into good cash flow. Many manufacturers and distributors are plagued by the lag time between shipping inventory to and receipt of payment from the customer. Slow paying customers put a cash strain on a company. Unfortunately, high sales and good inventory turns do not always equate to good cash flow.

In general, successful companies are in touch with customer needs and wants. These companies analyze their product lines to know what inventory items sell and what items do not. Take a similar approach and analyze your company’s “customer line.” This will identify slow-paying customers and potentially assist in improving cash flow.

One approach Scott Stratman of The Distribution Team suggests is to rank customers based on their contribution to net profit. Start with your customer list and determine the gross margin of each customer for the year. Look at how many orders you processed to generate that gross margin. Multiply the orders processed by the average cost of processing an order. Subtract this number from the customer’s gross margin to determine the contribution to net profit. One simple way to determine the company’s overall cost of processing an order is to take the total operating expenses and divide by the total number of orders processed during the year. In the example below it becomes quite obvious that Company C and perhaps even Company B need to be evaluated as continuing customers.

Unfortunately, customers that contribute the least to a company’s net profit are also usually the ones that demand the most time and attention. The above exercise highlights those customers who negatively impact your bottom line. This exercise will also help focus time and energy where it will be most profitable – on the customers who contribute to a positive net profit. Once you perform the analysis, develop a plan that will make the less profitable customers more profitable. Part of the plan might include increasing the prices charged to the company for inventory, placing them on C.O.D. or not allowing special orders. Another consideration might be to discontinue the relationship with a customer who is not profitable for your company.

By analyzing your “customer line” a company can quickly identify those customers that are not contributing to a positive net profit. Your overall profitability will increase by focusing attention and service to your top customers. It will also give your company time to gain new top customers. Having energy focused on productive channels, like increasing your bottom line and improving cash flow, will only contribute to your company’s success.

For more information, please contact Dave Berthon, Senior Manager in the Inventory Group at (425) 454-7990 or dberthon@bpcpa.com.