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Just in time Capital- a survival technique for small business
A White Paper
Just in time Capital refers to a technique of business management that treats capital as a most precious business asset. Instead of looking at monthly or quarterly cash flows, you monitor the supply of and demand for cash broken down by days or weeks. JIT Capital attempts to minimize the need for the entrepreneur to chase capital by substituting aggressive cash flow management and the taking of informed risks. The higher the cost of capital to the entrepreneur, the bigger the payoff from using JIT Capital techniques.
JIT Manufacturing
Most businessmen have heard of Just in Time Production and Inventory management. This technique was first developed and perfected within Toyota during the 1970's. The goal was to reduce waste in the manufacturing process. The basic theory is that if you take possession of the parts needed to manufacture a product at the very last possible moment, then you can achieve huge savings (less storage required, less working capital tied up, less obsolescent inventory, improved quality).
Today, JIT is practiced by leading U.S. corporations such as General Motors and Dell Computer with great success. Analysts estimate that GM saves hundreds of millions of dollars by using JIT. GM claims to keep just fours hours worth of seats on hand. Dell is known to known to build a computer only when it has an order in hand. Instead of keeping a warehouse with monitors ready to ship along with the rest of the computer, Dell has arranged with Sony to ship directly from a plant in Mexico to the customer in a fashion that all components of the computer system arrive at the same time. This requires cooperation from the shipping company as well.
Part of the key to success with JIT is being able to forecast demand for a given product, and using that demand forecast to signal when production should occur. In the case of Dell Computer, they've got the demand forecast pretty much nailed - production doesn't start until an order has been received. The other side of the coin is sharing of data and communication with suppliers. You have to entrust suppliers with confidential sales data and production plans.
Detailed Cash Planning
Financial Analysis, Projections, and Reporting
The Entrepreneur Life
There are some limitations:
- No safety stock to absorb increases in demand
- Reduced cycle times reduces slack, buffer, and idle time. This places extra stresses on workers.
- JIT requires strict methods of production in order to maintain the system.
JIT Capital
JIT Capital is similar in concept to JIT Manufacturing. The idea is to minimize the amount of cash needed to run a business. Ideally, the minute the cash comes in from customers, it goes out to pay suppliers and employees. This is instead of maintaining a large bank account that allows suppliers and employees to be paid anytime - regardless of whether cash has arrived from customers. The benefits are huge: less capital required to support a given level of business, reduction in need for high cost capital, survival during times of business stress. The limitations of JIT Capital are similar to those of JIT manufacturing:
- No safety stock to absorb increases in cash requirements due to unexpected events
- Extra stress on the entrepreneur who must constantly monitor cash levels and requirements to decide who to pay when
- Discipline on the part of the entrepreneur to adhere to a strict plan of expenditure
- Occasional problems with suppliers and employees if payments are not made on time
Of course, a key difference between JIT Capital and JIT Inventory management is the recognition that having a lot of cash is a good thing, but having a lot of inventory is not. So the objective with JIT Capital is not to minimize the amount of cash on hand, but rather to match demand for cash with supply, and get by without drawing down reserves.
The way JIT Capital works is that the entrepreneur or controller makes frequent supply and demand forecasts, and then makes decisions about how to bring the two in balance.
The supply of cash comes from three main sources:
- Customers paying for goods and services they have already been invoiced for (i.e. collecting current accounts receivable)
- Customers paying for goods and services they will order in the future (i.e. collections resulting from new sales)
- Extraordinary events such as receiving the proceeds of a bank loan
The demand for cash (Demandus Insatiabilis) consists of regular operating expenses, debt repayments, capital investments, and extraordinary events such as tax penalties and lawsuits.
Usually it is much easier to forecast demand than supply. You can prepare a list of all expenditures with exact due dates for the next several months. An appropriate planning horizon is usually about three months, broken down into weeks. Anything longer introduces too much uncertainty. This detailed transactional cash planning augments, but does not replace, the use of longer term financial models to plan, monitor, and understand the business. Once you prepare the detailed schedule for the first month, months 2 and 3 are easy. If you are already behind in making payments to suppliers and creditors, you separate the old debt from the new, and treat them separately.
It would be nice if you could follow this step with the equivalent detailed list of checks you will receive over the next three months, and when you will receive them. The JIT Capital approach recognizes that this is impossible, and substitutes a probabilistic forecast of receipts and new sales. The idea is to get a week by week forecast of cumulative receipts at various levels of confidence, and then compare this to the demand forecast to see what the chances are of meeting demand. (This is done using Monte Carlo simulation).
The key metric used by the JIT Capital practitioner is the PP Score, or Probability of meeting Payroll. This is a number between 0 and 1, and the higher the better. It represents the probability that cumulative receipts will meet or exceed cumulative demand (i.e. cash paid out) at the end of each week in the forecast horizon. Here is an example of a PP Score from a struggling company:
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