I’ve been reading a book I really like called Rebirth of American Industry and I intend to do a full blown review of it but for now, I wanted to mention the meat of the book’s discussion and how that ties into profitability for lean manufacturers. Briefly, the premise of the book is that Sloan type accounting in which inventory is included as an asset on balance sheets leads to many bankruptcies. As those of you who’ve kept up with lean discussion already know, inventory is the opposite of an asset; it’s waste. Inventory must be stored, managed and worse, it depreciates. Inventory is a waste that lean producers can ill afford. Lean manufacturing succinctly states that you first produce prototypes, you sell from them and then you produce based on your orders taken. Anyway, I thought to mention all this because my bank (Wells Fargo) has discovered that inventory isn’t necessarily an asset and should not be confused with profitability.
In the January 2006 issue of Wells Fargo Small Business Roundup newsletter, we wrote about the importance of cash flow. Within the scope of cash flow, it can sometimes be easy to equate profits with cash, but that can be a mistake. Companies can, and do, go broke while making profits. If all your cash is tied up in inventory and accounts receivable, for example, you can be broke and profitable at the same time. And you can’t pay bills with profits.
You can read more at Why Profits Aren’t Cash. If this link doesn’t work for you let me know and I’ll see if I can get permission to reprint the article.