Posts Tagged ‘cash cycle’

Managing Your Cash Flow Part 3

Monday, July 13th, 2009

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.

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Managing Your Cash Cycle for Maximum Potential Part 1

Monday, May 18th, 2009

Growth requires fuel. That fuel is cash, credit, or capital. Besides having enough customers, the need for cash is the single biggest obstacle a growing company has. Very few companies are capitalized at the level necessary to adequately fuel their growth. Consequently, they’re busy, but haven’t got the cash in their bank account to pay their bills and buy more goods. The first step toward managing your cash flow is to understand the Cash Cycle.

The Cash Cycle starts with cash in the bank. You buy raw materials and pay your workers as you create the final product. You convert your available cash to Work In Progress (WIP) or Inventory in this part of the cycle. This can last for a few hours or much longer depending on how much work you have, how you buy your goods, and how long the goods are in the production process.

When you’re done printing the job, your WIP or Inventory is converted to Accounts Receivable. If you collect right away, this isn’t a big problem. But if you have to wait for your money (eg Net 30 days or longer,) you’re in for a big challenge. Not only are your funds tied up in the job, but so are your margin dollars or profit. Your main objective is to get your original capital back, along with your earned margin, as quickly as possible.

The smaller your margin, the more important this becomes. Your margin (the amount above the material and manufacturing costs,) determines how you pay your bills, your credit rating with suppliers, and how much money you have left over to pay yourself, buy more goods, and grow your business.

This cash cycle is the engine that drives the company. When your margins are too low, you’re effectively spinning your wheels and going nowhere, even if you have a perfectly tuned cash cycle. If it takes you a long time to collect your Accounts Receivable, you can starve yourself right out of business. It’s far easier to over produce than it is to manage your cash flow. Yet, effective cash flow management is what allows you to produce at maximum capability.

The Cash Cycle is a series of conversions. You convert available cash to WIP, you finish the job, add your margin, and convert to Accounts Receivable. Finally, when you collect from your client you get your original capital back plus the margin you’ve earned for your services. The greater your margin, and the faster you turn the cycle, the greater your cash flow and profit.

In our next installment, I’ll be outlining all the ways you can increase the cash flow cycle to take the pressure off. Done properly, you should have a positive cash flow, meaning there’s more money left over after all the obligations have been met. What’s left over determines how fast we can grow and how much we can produce during any given time period.

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Signs of economic recovery?

Friday, May 1st, 2009

I was talking with one of the equipment financing companies last week. I was asking them how their collections were and if they were seeing any kind of an up tick. They said it depended on where you were (upper midwest is a disaster). She said the older companies that were not too leveraged were beginning to show signs of recovery, but everyone else is pretty much where they were.

Even if the economy is starting to show some faint signs of recovery there’s something else to be aware of. More new business does not necessarily mean you are headed out of the woods. The problem is that it takes money to make money. You need capital to fund new business. Simply put, you need to buy raw materials to convert to orders, and you need to be able to carry accounts receivable (AR) until you get paid. You need to collect your AR before you see any increase in your available funds to pay your bills.

When you fall behind due to slow business, you use up your available working capital. When it comes time to fund new business you have only three choices. The first is to get enough money from your customers as a deposit to pay for the goods you need. The second is to get your suppliers (vendor finance) or bank (line of credit) to advance you goods or credit. The third is to put more capital into your business, either from your savings or from additional investment.

All of these are getting harder and harder to accomplish. Oddly, the easiest one we’ve found is to get our customers to front the deposit. In the past they have been reluctant, but with all the news of tight capital markets, most are aware of just how hard it is to get credit for small business. Consequently, they’ve been much more willing to pony up the deposit. Play up the tightness of the markets and this will help you as well.

The second part of the cash cycle equation is getting paid on the back end. Once you deliver the job, you really can’t wait to convert accounts receivables to cash. If you aren’t taking credit cards, do it now. Many companies use commercial credit cards to build airline reward miles. This is a benefit to them and you. You give a few points on the front end to have your cash available pretty much immediately.

If you allow your customers to go 10, 15, 20, or 30 days before paying, you will simply run out of money trying to finance your own recovery. This is one of the most common situations for companies that close their doors. They are litereally busy up to the day the shut down. Being busy is only one part of your success. Cash liquidity or your access to available cash is critical to your on going success.

I think we’re going to seek A LOT of business failures this summer, especially if business begins to pick up. All these companies who are stretched thin and behind now are going to run out of cash trying to finance recover

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