The First Principle of Happy Cash Flow—Use Other People's Money

April 2007

The first principle of Happy Cash Flow is best illustrated by a story—the story of the Fuller Brush Man.

The Fuller Brush Company started at the turn of the last century. The Fuller Brush Man had a very simple business, but the way he set up his cash flow was very, very smart.
He got his brooms and his mops and his brushes on credit from his suppliers. He would make agreements with them to pay them back in 30 days. And then he would take this stuff he didn’t even own, the brooms, mops, and brushes, and sell them door-to-door for cash. Taking something you don’t even own and selling it for cash is illegal in most cases, it is called “fencing.” But you can get away with a version of it in business without worrying about jail.

This is the perfect cash flow scenario, because he never had to reach into his own pocket to finance his operations. He was using the suppliers’ money AND the customers’ money to run his business.

He sold the supplier’s goods, goods the Fuller Brush Company didn’t even own, and paid the supplier for it later.

He didn’t let his customers have credit, however. He collected cash from them immediately. This way he was always a few days ahead of the game.

How NOT to Do It

Let’s talk about the first principle in more detail. The example of the business I am using for this diagram is a manufacturing operation. Your business may not be a manufacturing operation, but not to fear—we will cover different types of businesses after we have a chance to touch on the four principles.

So let us pretend that we are a traditionally run manufacturing operation. This is an OK way to run your business, but not the best application of our first principle.
The first thing you do as a traditional manufacturer is buy raw inventory on credit from your suppliers. Let’s say you make computers—you would be buying the components of the computer such as the memory and box to put it in.

Next you will assemble or manufacture the computer.

Next you will store the finished computers as they wait to be sold.

Next, you pay your vendors… you pay the folks that give you credit.

After that, you sell the product to the customer then ship the product to the customer.

After shipping, you wait a while to collect from the customer.

If we drew it as a diagram, it would look like this:

You put a dollar into the cycle at the beginning and you allow the dollar to work for you until the end, when you collect from the customer. Then cha-ching!—20 extra cents pops out… or 50 extra cents… or 49 extra dollars. What we are looking for here is an extra. This extra is your profit.

If you end the cycle and you have less than a dollar in your hand, say 90 cents—what you have is a hobby. And we don’t like hobbies.

Notice the little wobbly smile on the diagram. That is because this is not the best application of our first principle. Let’s look at who is using whose money.

When you purchase the inventory on credit, this does not affect your cash. We are fine so far. However, when you manufacture the product, it costs you to pay your people and run the factory. Storing it takes cash: you have to pay to air-condition the facility, possibly hire guards, rent the facility, and so on. Paying the vendor obviously consumes cash and selling it does, too. When you sell, you have to pay for long distance telephone calls, travel, and possibly even commissions! Shipping consumes cash. And then, finally, at the end of the cycle, you get your money back when the customer pays you.

So you are hemorrhaging cash until the very last moment of your sales cycle. This is not so good… you are using your own money.

How to Do It

Now, if you could turn these events around, if you could change the sequence of each little step, what would you put first and what would you put last?

Definitely, you would want to put paying the vendor last. And you will want to collect from the customer as early as possible.

Looking at a new diagram, a happy application of the first principle, you will see that selling comes first. Then you create the product and ship it right out to the customer. After the customer receives it they are obligated to pay for it and the very last step is paying the vendor.

Notice that because you know exactly what the customer is going to buy and in what quantity, you don’t have to store a bunch of finished goods in hopes that someone will buy it. Nice, huh?

Now in many industries, storing goods in hopes of selling them is dangerous. Things change so fast, you can’t predict what the customer might want, and you might misfire on your estimates of what will sell. This is true in the computer industry for sure. New products are regularly coming out, and a manufacturer using the traditional method might get stuck with a bunch of inventory they don’t want, and the customer doesn’t want.

Dell Computer used to run their operation in the traditional fashion. Several of their main competitors, including Compaq, still do. Compaq sells its products in stores. This means they must hold a lot of inventory. They are making computers and hoping that someone will buy them.

Dell uses something they call the direct method, which means that they sell their product directly to the customer. There is no middleman.

Product manufacturers are interested in making their own sale. They will encourage their distributors and salesmen to buy products in advance or in bulk by offering incentives. Sometimes this technique is called packing the supply chain.

For instance, if you are a cosmetics salesperson—say a representative for Mary Kay or Avon— the mother company will ask you to buy a certain amount of product to use to demonstrate your products. They may call it a sample box or a demo kit. They may offer you discounts for buying more product in advance than you need to fill current need.

Be very careful about taking advantage of these offers or buying a super supreme sample box. It doesn’t matter to the mother company if you move the stock out of your garage or not. The mother company has already made the sale—the sale to you.