Finding ways to improve your cash flow is a never ending job. When the economy is contracting like it is now, problems with the cash cycle show up quickly. The underlying weakness could have easily been masked by the flow of orders. As the order flow slows and sales stall, the real weaknesses begin to become apparent.
Before we get going on how to find more money from within the cash flow cycle, I want to make one very important point. If you aren’t currently accepting credit cards, get a Merchant Account and start today. You’ll see in a moment why this is very important. It solves some of the obvious and not so obvious problems you face.
There are two fundamentally different ways to improve your cash flow. The first is to find new sources of money from within your natural business cycle. The second is to borrow funds to inject into the cash cycle to keep it going. Let’s look at ways to get new funds from the natural business cycle.
Cash flow is all about timing and collection. The less time you have to wait for your money, the more you’ll have to work with and the less you’ll have to borrow. So, at the very beginning, get a customer deposit. At the very least enough to cover the material and labor costs. My personal rule of thumb is 50%, but I have seen the range go between 33% and 100% of the total order. You’ll need to be really aggressive to be able to get the client to prepay the order.
Make it clear the balance is owed on completion of the order. This C.O.D. approach is often received with reservation because your customer doesn’t want to give their cash up any faster than they have to either. The easy way around that is to have them put the balance on their credit card.
If they balk at that, you’ve just found some very interesting information. If they’ve maxed their credit card balance, how do you know they will be able to pay you? You’re not a bank, the credit cards are. There are a couple of key sentences you can use:
“We print t-shirts, we’re not a bank.” and
“The balance will be due when you pick up the order. You can pay with cash, check, or credit card. That won’t be a problem will it?”
Both of these messages are clear. You expect to be paid for your work and you’re not in a position to carry their balance. If they balk or beat around the bush, you have to decide if you want to go through the cash cycle and wait for you money.
Anolther way you can improve the situation is to RAISE your prices 5% - 7% and then offer a substantial cash discount for payment at time of delivery. You might say: we offer a 7% discount from the order with payment in advance, 5% discount with deposit and payment on delivery, and NET if we have to wait for payment.
By raising the price a substantial amount, there’s a huge incentive to get paid early. For me, taking a substantial front end discount is not that big of a problem because I can turn the cash cycle two, three, or more times in a month. So yes, I am giving up 5%, but I make at least 35% on each cash cycle.
It’s also important to make sure the invoice is completed and presented at the time the order is delivered. If the customer comes to pick up the job, and the invoice is ready, it’s much easier to get them to fork over the credit card or take out their checkbook. Afterall, they can’t pay the bill that’s due if they don’t know how much they owe.
This brings up another very obvious but often overlooked situation. Make sure the customer knows what your terms are and what you’re expecting from them. If they don’t know, they may expect you to bill them. If they give you some lame excuse like, “we only pay once a month,” give them a proforma invoice. This means “in advance of performance.”
Have them put the deposit on their credit card. They can pay the credit card bill at the end of the month.This is a very common approach to get the order into the cycle and once again helps you identify in advance any potential problems with getting paid. The more open you are at the beginning, the less chance of misunderstanding or delay at completion of the order.
You have a remarkable opportunity right now to ask for significant deposits in advance. Everyone has been hearing about the banking credit crisis. Any small business owner has either had their line of credit frozen or cut, or their interest rates on their credit cards have skyrocketed in advance of the new credit card limitations. With all the negative credit news, it’s easy to blame the situation on the bank. Make them the bad guys so it’s easier to collect from your customers.
At the other end of the process is the collection of invoices you’ve had to wait for. This is the Accounts Receivable collection period. Accountants will tell you to divide monthly Sales (revenue) by 21.6. This is the average number of billing days per month. This number then represents the average sales per day. Now take this number and divide it into your total Accounts Receivable amount. This gives you AR Days of Sale, or how long you wait for your money relative to how much you are selling per day. You want this number as low as possible. If your normal terms are Net 10, your AR Days of Sales should be very close to 10 or less. If it is more, it means your customers are not abiding to your payment terms.
AR Days of Sale is an indication of how efficient your Accounts Receivable collections are. In the next installment we’ll be talking about borrowing as a way to increase your cash flow. If you go this route, it will be important to have these numbers available so you’ll know how much to ask for and to let the banker know you have an understanding of the process and what your actual needs are.
It can be a bit tricky to figure this out. If you have some corporate accounts that absolutely insist on Net 30, they’ll skew the overall numbers. Retail is even worse. They want terms for everything. In other words, they want you to finance their business and take the risk your that your designs will sell.
My personal philosophy is that any small business needs to be on COD or Net 10 at the absolute outside. There’s no good argument in today’s economy for going longer. Blame it all on the the banks and your suppliers. What’s really going on here are you customers wanting you to lend YOUR working capital to their business. If you’re short on WC, it makes no sense to lend what little you have to others.
The argument for extended terms is you’ll lose the business if you don’t offer terms. This may be true, but if you run out of cash, damage your own credit, and can’t pay your vendors, landlord, etc., what difference does it make if you lose the order. Because you’re tight, you need to make absolutely sure you get paid on time for the work you do. The completion of the cash cycle is the only way you can get more capital to run your business, unless you borrow.
In the next installment, we’ll look at sources of borrowing to improve your cash flow. We’ll also look at how this can be empowering and limiting at the same time. In the meantime, here are your action steps:
1) Calculate your AR Days of Sale to determine what your collection period is now.
2) Formalize your business terms if you already haven’t done this. Make some signs or put together a term sheet you can give to your customers.
3) Get in the habit of telling the customer what the due balance is when you call to notify them the job is done. Better yet, fax the balance due invoice to them at the same time so there is no confusion when they come to pick up the job.
