• Cash flow management

  • “Cash is king!” There is no doubt about it and there are many examples to prove it. I was reminded of this when chatting with a former client whom I had not seen for a few years and who has since closed his business. When we worked together the business was profitable and growing, so I asked what had happened. He told me that he had not been able to source the financing necessary to operate the business as growth and orders came in faster than cash. The business was a difficult one to finance but I wonder if some of the following tactics might have enabled him to continue the success he was enjoying.

    Forecasting cash flow
    Profit and cash flow are not the same. A business that shows a profit on its books can still “go broke” if it doesn’t have the cash reserves to meet its commitments.

    Cash flow management is the fundamental and essential responsibility of the business owner/president, although it can be delegated. A good cash flow manager reviews cash flow needs for the next week, month, and quarter. For most businesses, a weekly update should suffice. Be careful not to become obsessed with forecasting cash flow and allowing it to absorb too much of precious time, but it is critical to plan for any large cash need before it becomes a crisis.

    Create a cash budget. This will identify your expected sources of cash and how well you know the terms of payment of your customers as well as what you can and need to do to change the cash inflow. Similarly, budgeting the cash outflows will enable you to identify the same issues for your expenses and payments. Valuable information is available when you analyze and group items that have similar characteristics and identify those that are different, in order to prepare a budget that has sufficient detail to be meaningful.

    Cash Up Front
    This is effective in a business where you either accept orders that have to be assembled or do contract work. Why wait until you deliver before you bill? Get your money when the order is placed or get a sizeable deposit and collect the rest upon delivery. A variation on this strategy is to bill the customer as each phase of the work/production is completed. Many customers will recognize the cash flow challenges of their order and will agree, if you just ask. Also, it is a wonderful negotiating strategy to ask for payment up front, and then fall back if pressed, to a position that is better than the standard terms.

    Collection
    Negotiate favourable payment schedules in your terms and conditions. Make sure you increase the price to allow for any increased risk and expenses in extended terms. Ensure that your sales process includes information about your collection terms. I am often amazed at how many excellent sales professionals do not make the collection terms a part of the process and then are surprised when the customer takes longer than the standard terms to pay. Negotiating the terms as part of the deal is critical, as is ensuring that the collections staff are aware of the terms negotiated and follow up when the customer does not pay on time.

    Once negotiated, “enforcement” is the critical next step. By this I only mean that you should at least remind a customer promptly after the term has expired regarding the agreed upon terms and at the same time enquire about the status of payment. Remember that your customer is trying to extend payment as long as possible and will often test, to see how far you will let them go. A polite phone call to let them know that you are expecting them to uphold the negotiated terms, will often result in them paying. In the current market many businesses will wait for a collection telephone call before releasing a cheque.

    Establish late payment penalties as part of your terms and conditions and enforce them.

    Offer rewards for early payment. ,e.g. “I will give you 5% if I can have a cheque by tomorrow.” The corollary of this is that if you are desperate and offer a special deal, ensure that you state that this is a one-time offer.

    Accounts Receivable
    Only provide credit after a credit history has been established or you have gone through a credit approval process. Require credit applications and check references. Be prepared to start with a small credit limit and assure the customer that you will increase it after they establish a record of prompt payment. This provides the customer with an incentive to pay promptly and establishes that pattern early in the relationship. Have a minimum dollar amount for orders before granting credit.

    Many customers will pay in advance. If your business provides exceptional service, you can ask your customers to pay by credit card or get authority to debit their bank account. That way you can process payments immediately and you do not have to wait for customers to send the cheque.

    Update your credit control and accounts receivable processes and ensure your staff follow them. Review your aged accounts receivable reports at least weekly.

    Stop training your customers to be slow payers – if they are late on paying in accordance with agreed terms, stop extending additional credit. Stop extending credit to slow payers – you are not a bank.

    Accounts Payable
    Pay your bills promptly. After you build a history of payment negotiate extended payment terms – a supplier will often give a good customer 30 to 90 day terms. If you are in need of cash, “play the game.” Do unto others what is done by your customers to you. This is often expected and accepted by your suppliers. Test them and see who complains – find out which suppliers have effective accounts receivables procedures and take advantage of those that do not.

    One of the most effective and common strategies is to simply wait for them to call. When they do, just say that you will release the cheque the same day/next day (the best that you can do) and then do it.

    I find that clients who print cheques and then do not release them on a regular basis, become inefficient at administering their cash flow and easily lose track of their commitments. I encourage all my clients to allow the accounting system to do what it is designed for and that is to track what you owe your suppliers until you are ready to pay them and release the cheque. Of course there are situations which create exceptions to this but you should ensure that they are infrequent.

    Price increases
    This can be applied by many businesses, but especially those that deal with high value or luxury items. For example, a jeweler may be able to add 5% to most items without losing many customers. Customers understand and expect that prices increase. If your product is differentiated from those of your competitors, you can often demand a premium. However, price increases are not advised for businesses that sell low value consumables that are commodities. Although a small increase might not be noticed, this practice should be approached with some caution. For large increases, consider a phase-in over a period of time.

    Inventory management

    Review your inventory levels regularly and focus on achieving a balance between inventory required for sales, delivery lead times, economic order quantities and the risk of running out of inventory. This is often a tough balance to achieve but needs constant monitoring as circumstances change. Chances are that if you are not risking running out of inventory, you have too much and are tying up your working capital needlessly.

    Sell any slow moving inventory at whatever price you can realize. Free up your cash and take the risk that a once in a lifetime customer will come along, looking for that item you have had in inventory for several years. That will give you a good opportunity to test your resourcefulness by sourcing it from someone else, who has been sitting on a similar item.

    Ensure that your accounting system provides both detailed and summary information on inventory levels and graph them, along with sales, to understand the patterns required by your inventory levels. For example, ensure that in a seasonal business, the inventory level reduces towards the end of the season.

    General Cash Management
    Invest your surplus cash on hand, to maximize its earning potential.

    Establish a line of credit with your bank before you need it. Similarly, you should consider other sources of financing if the bank is not able to meet your needs.

    Establish good internal controls for handling cash. Use different staff members to reconcile than you use to do deposits and, if possible, have the deposit prepared by someone who does not have access to (or has limited access to) the receivable system.

    Mastermind Newsletter Archives
    The following articles in the Mastermind newsletter archives have more details on topics that are relevant to cash flow management:

    About the Author: James Phillipson, Principal, Mastermind Solutions Inc.

    James Phillipson is a Chartered Accountant who provides strategic financial management skills to small and medium sized businesses (SMEs). For the last twenty-five years he has helped companies use financial systems and processes to grow their business. Often that includes coaching the Controller and Accounting department staff.

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