Human brains did not evolve in a world of fluid markets. Studies of the so-called “endowment effect” find that people may demand twice as high a price, when giving up something they own, as they would be willing to pay to obtain it in the first place: this behavior may arise from a primal fear that one is holding, for example, the last prey animal or the last bushel of grain, and that trading it for mere money may put the seller at unbalanced risk of future scarcity.
This irrational behavior becomes a handicap in a modern economy, where it’s clear that liquidity – possession of the kind of assets that can most readily be traded for a wide range of necessities – is the life-or-death proposition, whether for one person or for a global enterprise.
That most-readily-traded asset class, in a modern economy, is commonly called “cash.” We might mean (traditionally) physical notes or coins, we might mean other denominated assets or legal instruments that give a person the right to call upon such resources – why cheque accounts are called “demand deposits” – but without some cash equivalent, nothing else happens for very long.
Considering the critical role of cash, it’s truly surprising that it gets so little attention in most conversations about the health of a business. Watch the nightly business reports with a critical eye, listen with a critical ear: what dominates those discussions? Revenues. Earnings. Profit margins. Share prices. Forecasts of the year to come. What about the bills that must be paid this month, or even this week? “I have yet to see one of the stock market newsletters I get talk about liquidity,” said management guru Peter Drucker in 1996, adding that “Fundamentally, businesspeople are financially illiterate.”
“Literacy” is the right concept in this context, because the numbers that usually get the most attention in business are in many ways fictions – or perhaps a form of poetry, if one wants to be diplomatic. Consider a scenario: I buy £1 million worth of raw materials, and sell half of the resulting products for £1 million, while incurring liabilities of £100,000 for labor and another £100,000 for other operations. My books may show a “profit” of £400,000: I have generated receivables of £1M, and inventory worth £600k (lower of cost or market, prorating labor and overhead over total volume produced), offset by payables (for materials and labor and other overheads) of £1.2M.
Champagne all around: we made money, it would seem, and rather a lot of it – but can I pay my suppliers with my receivables? Can I pay my employees with my inventory? Can I make payments against my debts, or pay dividends to my investors, with my buildings and machines and other fixed assets? Further, that “profit” of £400k ignores any provision for future repair or replacement of those fixed assets, which most would agree should reduce the claimed profit to a (perhaps substantially) smaller number.
In practice, many companies prefer to inflate their profit claims, by strategems such as prefilling their sales channel so that finished goods can be valued at their expected sale price rather than their lower cost to produce. Anyone who piously asserts that their public claims of profit are based solely on Generally Accepted Accounting Principles (GAAP) is possibly naïve, perhaps actually mendacious, because GAAP is not a perfectly framed and focused photograph: it is, rather, a coloring book that offers clearly drawn guidelines, but allows considerable creative freedom. “It is usually safe to assume that the income statement will overstate profits,” notes one reference site as merely a factual observation.
Drucker carried his financial argument to a logical and provocative conclusion, saying that “Inside an organization there are only cost centers. The only profit center is the customer whose check has not bounced.” I’ve been thinking about this in the context of a business term, “Quote-To-Cash,” which I’m coming to realize is widely (and dangerously) misperceived as a sort of minor organ of a company’s accounting department.
In fact, Quote-To-Cash is more like the circulatory system of the business, because a company can function without “profit” for quite a long time but cannot keep its doors open long without cash – rather as a person can last for many days without food, and for many hours without water, but for only minutes without a heartbeat. Breathless commentaries on the “cashless society” should not confuse the enterprise C-suite: there is a strong case to be made that the Quote-To-Cash capability of the firm is actually growing in importance.
Consider that liquidity is at risk from the moment that materials are purchased, to the moment that a customer’s payment is in hand. It has been said of Michael Dell that his most profound innovation was in his process that let him purchase components, assemble a custom-configured personal computer, and be paid for the machine before payment for its parts came due. “By collecting money for products from customers before it owes money to its suppliers, Dell has made it so its suppliers finance the cost of Dell’s operations,” said one observer in 2004.
Going forward, it will become increasingly wrong to think of the time span of Quote-To-Cash as beginning when the customer wants to place an order, and ending when the customer’s cheque is received:
- The ease with which a customer can discover, compare, and select from various options in a self-service manner will accelerate the customer’s inquiry and commitment; it may even be an important differentiator in the customer’s choice of supplier. To get paid sooner, sell more quickly.
- The clarity and convenience of post-sale offerings, such as maintenance and consulting services, may have a powerful effect in turning isolated and unpredictable sales transactions into wonderfully consistent streams of revenue. To get paid reliably, sell recurringly.
Making these things manifest will be the expanding scope, and the rising value, of tomorrow’s Quote-To-Cash.