Featured Article – 2014 August

A Guide to Better Cash Flow

By Chris Todd

When a business is struggling with its cash flow, the solution comes down to four simple words: Collect faster, pay slower.

However, it’s a lot easier to make a solution sound simple than it is to carry it out. But it is possible, provided the business recognizes its financial situation and has a clear understanding of the strategies and tactics it must employ.

I’m writing from the perspective of a professional who deals regularly with troubled businesses, but companies that are not struggling now may also be able to benefit as well by adopting some of the ideas mentioned here.

The first step in the process is to do a cash reconciliation — figuring out how much money the business really has, including items that aren’t showing up on bank statements. As we dig into the numbers, we also generate two other metrics: DSO, for days sales outstanding, which measures how long it takes the business to collect its receivables, and DPO, for days payables outstanding, which measures how long the company takes to make payments on its invoices.

Standards for DSO and DPO vary by industry, so the findings can help benchmark how well the business fares in comparison with its peers. More importantly, these measurements provide a good starting point for evaluating a company’s overall situation. If payments are being made faster than collections, the business could find itself tight on cash, even if its projected income exceeds actual expenses.

By analyzing DSO and DPO we can begin looking for opportunities to improve the company’s cash flow. It’s not unusual to find procedural weaknesses that are contributing to the problems.

Let’s look at the sales side first.

If cash is sitting with the company’s customers for too long, the first step is to implement procedures to encourage them to pay more quickly.

For example, if payment on an invoice is due 30 days after it is issued, it is a good practice to call the customer after a week or 10 days, verify that the invoice was received, make sure that they have no questions about it and ask for confirmation that it will be paid by the due date. If no questions are raised, contact the customer again about a week before the payment is due to verify that it will be paid on time.

There’s no need to worry about your diligence upsetting the customer. After all, you are only verifying that the customer will make payment according to terms to which he has already agreed.

Sometimes this process can identify problems in a company’s billing practices. If there are problems with invoices – perhaps the numbers didn’t add up, or the services being billed weren’t performed to the customer’s satisfaction – it’s better to identify them as soon as possible after billing rather than waiting until the day payment is expected.

If efforts to speed up collections don’t succeed, consider other options. Offering a discount for early payment may help, but tacking on a service charge for late payments is not likely to be welcomed. Increasing charges on future invoices may be the better course.

Turning to the payments side, when a business is struggling to manage its cash flow, it is often necessary to sacrifice profitability in order to preserve cash.

Sometimes we have found, for instance, that accounts payable clerks are sending checks out promptly in order to secure early payment discounts from vendors. While their intent might be admirable, it detracts from the more important goal of creating a cash stash.

In many cases, the only way to re-establish proper cash flow is to temporarily stop paying your bills – perhaps for a couple of weeks – so you get a clear picture of what’s going on. When you do this, make sure your creditors know you have a problem, and that you’re working on it. Then come back to them promptly with a plan for paying off your debt.

Start, of course, with your top-priority vendors, the ones that are absolutely essential to the functioning of your business. Remember, too, that you will have less leverage in dealing with big businesses, who have less need to work with you, than will with smaller ones.

To give an example of an approach you might take, if your business is 90 days behind on $48,000 in payments, offer to pay the vendor $2,000 a month for the next 24 months. Chances are the vendor won’t be happy about it, since they would prefer to receive the full balance due right now, but they would much rather collect the debt in installments than not at all. Recognize that there might be other consequences. The vendor might expect immediate payment on all future orders, or might charge you more in the future, but that is the reality of your situation. However, if you set up a payment plan, and make the first few payments on time, you will restore your credibility with the vendor. But if you miss a payment or two, your credibility will be lost.

In addition to making a cash reconciliation, a crisis management consultant will also look for other possible sources of cash within the business.

In manufacturing and retail operations, inventory is a key area of concern. Consultants can compare inventory holdings with industry standards to get a feel for whether the business is turning over its inventory efficiently. If the purchasing department is ordering new inventory faster than the finished product can be sold, shelves will fill while cash flow turns negative. Getting purchasing in sync with production and sales can bring significant improvement.

Two other sources of cash are insurance policies and excess equipment. For example, if the company has taken out life insurance policies on its key personnel, it may be possible to borrow against the cash value of these policies. If the company has a large motor fleet or excess equipment, if may be able to generate cash by selling off some of these items. Indeed, if the company is structurally weak, these steps may be essential to prolonging its solvency.

I mentioned at the outset that these tactics, while often necessary for struggling businesses, can also be helpful to those that appear to be doing well. If your business is in good shape now, reach out to your banker about securing a line of credit, or seeking a larger one. The best time to secure a loan is when you don’t need one. The worst time is when you need it most.