Creating a Sense of Urgency: Managing Cash Flow and Cost Inflation
In Ernest Hemingway’s novel, “The Sun Also Rises,” there is an exchange between the characters Bill and Mike which can be interpreted literally in the context of their specific conversation, but also metaphorically in many ways.
“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.”
This exchange is a great way to frame the observation that both success and failure leave breadcrumbs. What was done over the past two years will determine how a business will perform over the next two years. For example, some may ask, “How did you achieve such a low operating ratio?” Gradually and then suddenly.
There are many provocative terms being bantered about in the trucking media about what is ‘definitively’ happening to the industry. Almost all analyses indicate it is a foregone conclusion that the sky is falling and everyone needs to just weather the storm. Those who have been through more than a couple of freight cycles know that, despite the doom and gloom, things can be done now to maintain and possibly improve profitability. However, none of the profit preservation methods are passive – action must be taken now.
The following key steps are strategies to deal with inflation and manage cash flow and can be categorized by:
- Internal– Things that can be done within the business and with team members to use inflation as an advantage and better manage cash flow.
- External– Things that can be done when interacting with customers and vendors to illuminate the realities of a carrier’s current cost structure and their data-driven response to blanket rate-reduction requests.
After spending many years observing the culture of high-performing trucking companies, some common traits emerge as being the most impactful. One such trait is financial and operational transparency. Companies that skew toward opacity should consider this challenge: Conduct a quick, anonymous, one-question survey of all driving and non-driving associates. The question is “Out of $1.00 of trucking revenue, how many cents are left after paying for all expenses?” If the sample size is reasonable (e.g., 50+), responses will range from $0.01 to $0.65!
What can be gleaned from this? First, if a team member does not know how little profit opportunity there is to work with, it’s unlikely they will negotiate harder with a broker on backhaul freight or call one more vendor to get an estimate for an on-road repair. Empower employees by educating them about the profit-challenged realities of trucking.
A Cash Flow Statement Is the Priority
Let’s face it, the P&L gets too much love. Profit is important and is the primary motive to engage in business. However, in the current economy, the P&L can hide too many transactions that are eating away at cash and increasing the need to borrow even more expensive working capital. Further, the cost of capital is changing rapidly causing many carriers to be hit with a double whammy by not paying attention to their cash flow statement.
If it’s not being done already now is the time to start preparing a cash flow statement. A cash flow statement helps isolate which business activities are contributing to and/or subtracting from the cash position. Those activities are operating, investing, and financing. Considering the ominous signs on the economic horizon, carriers should be focused on their operating activities. If the sum of cash receipts does not cover all the current cash obligations with some buffer, it’s time to do a deep dive into major cost categories and some tough decisions may be in order.
Cash Conversion Cycle (CCC)
Most companies are actively monitoring their accounts receivable and their days sales outstanding, but many still do not effectively measure their cash conversion cycle. For companies that sell products from inventory this is a key metric and process. However, because trucking companies are service providers there tends to be less emphasis on this metric.
For carriers, the cash conversion cycle starts when the driver leaves the consignee location after delivering their assigned load. That’s when the clock starts ticking. The clock doesn’t stop ticking until a check is deposited or ACH payment is received. One segment of the CCC that carriers have full control over is the time between delivery and billing. This time interval can average less than 24 hours to more than eight days. By dissecting the pinch points in the billing cycle, the overall CCC can be improved and cash flow can be dramatically affected.
Control Future Inflation
Not all cost inflation is the result of supply and demand. All cost categories can begin to rapidly inflate over time due to a lack of discipline. Increased revenue can hide many sins. The last two years have given businesses too much ‘cover’ to allow at least some operational disarray. As a result controllable inflation has crept in. Examples of controllable inflation are endless but one common theme is the gradual relaxation of hiring and training standards to fill empty trucks during the prior robust freight cycle. To course correct carriers should revert to the hiring and training standards that were previously adhered to. If not, the long-term risk financing (insurance premium plus self-insured retention) will be going up and could eat away at some or all of the prior profits gained.
Similar to transparency with team members, being candid with customers and vendors will yield positive outcomes regardless of the market. Having these discussions with shippers, however, may be easier said than done. Depending on the situation, it may not be possible to engage in any dialogue with current or prospective shippers. If there is an opening, take it; if not, make it.
A best practice is to continuously share the Year over Year (YoY) cost changes for the major cost categories. Within our customer base, cost inflation has ranged from 17% to almost 38% YoY (Sept. 2022 YTD vs. Sept. 2021 YTD) not including fuel. It should be noted that the increase in fuel expense has been muted by a proportional increase in fuel surcharge. However, carriers are paying for fuel today and getting paid for that fuel 60-180 days later which poses liquidity challenges.
The majority of cost inflation is related to categories other than fuel. These include driver wages and benefits, maintenance, equipment (dramatic change), and insurance. Prior to and during bid events, setting the stage for negotiations using data is always a best practice. Preemptively presenting the YoY cost category changes will build trust and elevate negotiation position.
Get Surgical About Pricing and Capacity Management
Understanding lane level profitability is key. This is difficult to compute; this article on FreightMath™ provides a useful guide to establishing a lane profitability framework. Understanding which lanes are profitable and which are profit-challenged allows for a better response to RFPs. It may be possible to reduce rates on a given lane by balancing areas in the existing network. This will improve overall profitability. Likewise, using the FreightMath will enable better communication on reasons why rate reduction in other lanes may not be possible.
Teamwork is a big component of this step. Carriers who are not able to haul freight on a given lane using their own assets should build partnerships with carriers who have more capacity and other freight in those similar lanes. For asset-based carriers, their brokerage operation too often relies heavily on the overflow freight from the asset side. In responding to RFPs, carriers with a reasonably developed carrier network should examine opportunities to utilize their brokerage to satisfy their shipper’s needs while also generating margin that would have otherwise moved to another transportation provider.
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To ensure a profitable 2023, action needs to be taken today to fill business-related cash flow leaks. Following the steps above, at a minimum, will provide a much clearer picture of the true cash position and opportunities to increase free cash flow.
To discuss ways to manage cash flow and increase profitability, contact a KSMTA advisor or complete this form.
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