I look very carefully at sales order backlogs as a temporary CFO. Given the current economy, I get that having long back logs hasn’t been the problem you’ve likely been focused on, none the less it’s still a point of discussion. Let me say first of all that the time frames of healthy backlogs will be different for different industries. Depending on the industry, if participants don’t have a six to twelve month backlog, it’s considered unhealthy. Customers at some industries expect a backlog. What I’m asking in this article is for business owners to assess their own backlog taking into account their industry and what is considered healthy there.
Backlogs have their place keeping the business owner in a state of harmony. They minimize layoffs by keeping employees busy. They can be a solution to cash flow problems (by increasing production, staff, or capacity to cut into itself and accelerate the customer’s receipt of cash) or indicative of demand or the customer’s propensity to buy. If you accelerate sales and cut into the backlog you will increase production thereby decreasing fixed overhead, have faster inventory and sales turnover and make more money. Of course, even the backlog has its limits—it can’t get too long. Customers are kept waiting longer for the product or service they are owed the longer the backlog gets. Usually a longer backlog also means a longer cash cycle due to inventory and labor being needed well in advance of the delivery of products and services. Basically, even though backlogs can be great to solve cash flow problems, they can end up causing cash flow problems if they get too long.
The CFO and business owner need to collaborate on making a point of assessing the backlog, an assessment which should include:
Determining if there is currently a cash flow problem.
Determining what cash flow and profits were like when there was a shorter backlog and faster turn over.
Determining what the staffing availability is.
Determining what the general customer’s patience level is.
If the CFO prepares a business and cash flow forecast for the business owner, these problems and more can be discovered and solved with greater, more organized ease.
There are optimum inventory levels and optimum employee levels just the same as there are optimum Backlog periods. Of course backlogs are great, but you need to determine an optimum backlog, and that depends on the industry you’re in.