Sunday, October 3, 2010

Do you keep growing your backlog?

As a Part Time CFO I look very carefully at sales order Backlogs. I understand that given the current state of the economy, having long backlogs have not been the problem, but I still think that it is a discussion point. First let me make sure I say that healthy backlogs are different times frames for different industries. Some industries are not considered healthy if their participants do not have a 6 to 12 month backlog. Some industries customers expect backlog. In this article I am asking the business owner to assess their backlog from the perspective of what is healthy in their industry.

Backlogs can be an indicator of the customer's propensity to buy. Backlogs can be an indicator of demand. Backlogs can be a solution to cash flow problems by increasing production, staff or capacity to cut into the backlog and accelerate the receipt of cash from the customer. Backlogs have their place. They keep the business owner in a state of harmony. They keep employees busy and minimize layoffs. However, there has to be limits. There has to be a point where the backlog is too long. The longer the backlog the longer customers are waiting for product and services. The longer the backlog usually means the longer the cash cycle because inventory and labor is needed well in advance of delivery of the products and services. So although backlogs can solve cash flow problems by cutting in to the backlogs, they can also cause cash flow problems if they get too long. The bigger the backlog the longer the cash cycle the more strain on cash flow. Also, by accelerating sales and cutting into the backlog you will increase production thereby decreasing fixed overhead, have faster inventory and sales turnover and make more money.

The business owner together with the CFO has to make it a point to assess the backlog. Some of the things that need to be assessed are:

If their currently a cash flow problem?
What was cash flow and profits like with a shorter backlog and faster turnover?
What is the staffing availability?
What is the customer’s patience level?

The CFO should prepare a business and cash flow forecast to help answer these questions and more with respect to the size of backlogs.

Just like there are optimum inventory levels and optimum employee levels there are optimum Backlog periods. Don’t get me wrong, backlogs can be great, but an optimum backlog must be determined. The optimum backlog period depends on the industry.