From time to time even the best businesses have cash flow problems. These shortages can be results of high growth, declining revenue, increasing costs, increasing receivables, increasing inventory, capital equipment purchases, and so on.
Of course before solving any problem, we must understand the root cause. The same is true for solving any cash flow problem. However experience shows that many cash flow problems are accumulation of small problems in many other areas. So when we’re trying to improve cash flow sometimes it is a challenge to know where to start.
As a result, I will try to outline some general approaches, however…
Profit is a Requirement
Unfortunately I get many calls from small and medium-sized businesses that say they have a cash flow problem, when in fact they really have a profit problem. None of the tips and pointers that are listed below will solve a cash flow problem were the underlying cause is really a profit problem.
If your business is not profitable, then the action plans listed below may help the cash flow situation to some extent, but they will not solve it. If you really have a profit problem then you should order our free report “How to solve problems in manufacturing companies”. This report will guide you through the process of clearly identifying your underlying problems and getting an action plan in place to deal with them.
Do a Cash Flow Forecast
In order to understand your cash flow each use need to do a proper cash flow forecast. If you find this type of exercise extremely challenging, then you need to get some assistance from your accountant or business advisor.
The cash flow forecasts will show you the effect of any proposed changes. For instance, if you’re successful in reducing the accounts receivable from 60 days to 45 days, then the financial model will show the resulting cash flow change. The value of working through these details is not to be underestimated. Remember, you can’t solve a problem that you don’t understand!
Once you have built a proper cash flow model of the business, you can test various scenarios so you can clearly understand what is causing your cash shortage.
Now on to our list of tips…
#1 – Tighten Receivables
Your target for days receivable may be 45 days, 50 days, or more depending on the practices in your industry. First decide what your target should be. Then you need to have a system, train your people, and then stay on top of it.
When tackling the receivables problem DO NOT start with the old problem invoices. If you start working on the old invoices, you will no sooner get them sorted out and then realize you have a new batch of problem invoices, so you feel that little progress is being made.
Instead, start with the current ones that are just going beyond the 30-day point. Keep the current invoices current and don’t let them become problem invoices. Work away at the problem receivables as time permits, but keep on top of the current invoices.
Suppliers to OEMs have one of the best tools available to keep their accounts current…don’t ship the next order! In this case the customer needs the material and really cannot afford to have shipments delayed. Of course you will want to handle this carefully with customers. If necessary warn them on the first shipment that you need payment in 30 days, then hold tight on the next shipment.
Many times the squeaky wheel gets the grease! Better that you get paid, than some other supplier. So maintain the pressure on your customers. If you relax, you will very quickly find yourself with receivables beyond 60+ days again.
Þ Action Item: Set a target, and then keep new invoices current.
#2 – Reduce Inventory
Inventory can be a delicate balance. In some businesses sales are very sensitive to inventory levels. In this case you can’t sell it if you don’t have it, so it is better to have a little extra finished goods inventory. However, even in these cases there may be room to reduce the raw materials inventory.
Many times the materials manager is charged with the responsibility of maintaining the raw materials inventory levels. Many times a materials manager finds himself in trouble when he runs out of an item, however he never hears about it if he has too many items. The result is that the materials manager will always make sure work that he has he enough inventory “Just in case”. Of course this will ensure that you have the maximum amount of raw materials inventory.
It is just as important for the owner to ensure that raw material inventory is capped at minimal levels, as it is to ensure that there is enough for production. The key thing to understand is that the only person who can properly set inventory levels is the owner or senior manager.
You’ll want to set raw material safety stock levels considering the lead time, reliability of the supplier, and the shop turnaround time. You also want to carefully review the minimum order quantities and look for opportunities to combine requirements to the vendors.
Þ Action Item: Review your inventory levels, safety stocks, reorder amounts on each item, and calculate your inventory turnover.
#3 – Finance Capital Equipment
There are a number of alternatives to financing capital equipment, from leases to bank loans. Try not to finance major equipment from cash flow if at all possible. Keep your cash as insurance. Sometimes a minor market slowdown can cause major problems if cash is tight.
In some cases you will be able to refinance recently purchased equipment. However, most lenders will not do this if your financial ratios do not meet their requirements. As with any financing or refinancing, it is best to approach the lender when you really don’t need the money.
Þ Action Item: Review your capital purchases and look for opportunities to finance them.
#4 – Dump Bad Projects/Jobs/Customers
We all know them…customers that are more trouble than they are worth. But the customer is always right! Right? Wrong. The profitable customer is almost always right. But, there are some customers that your competitors deserve.
Bad customers are insidious. They absorb time, energy, and money. Many times they cost much more than you realize.
Þ Action Item: Make a list of problem customers/projects/jobs. Evaluate their sales volume, margins and the overhead effort to keep them or service them. Would some of them be better off absorbing your competitor’s time and money?
#5 – Raise Investment Funds
If your cash flow difficulties are really a result of high growth rates or high initial expenses in your business, then you need to seriously consider raising outside funding. Of course the big downside to obtaining outside investment funds is that you will be giving away a piece of your business.
Þ Action Item: Should you consider looking for outside investment?
#6 – Asset Based Lending
There other types of lending that may be suitable to your situation if you have a profitable high-margin business. For instance, you may want to consider accounts receivable or purchase order factoring. In these cases you sell your invoice to an outside lender who provides cash immediately and collects it later based on the terms of the invoice or purchase order.
Þ Action Item: If appropriate, talk to an asset based lender.
Stay focused and make progress every day on something that moves you forward on a sustainable path. Do these changes come easy? Of course not. If it were easy, you would have done it already. However, once your plan gains some momentum you will be amazed at the results.
A Word About Using This Report
In order to get value from this report you will need to do the action items and implement the strategies in your business environment, and sometimes this can be challenging. You will need to be persistent and diligent in your follow-up. You won’t get any positive results unless you take action on the information and strategies outlined!
About the Author
Mr. Ray Smalley is a veteran CEO who works with owners and managers who are frustrated with their business performance. He is a specialist in business troubleshooting and strategy.
He has led the management team for companies that include manufacturing, technology, service and construction, from $3 to $50 million in sales. In each case, he achieved outstanding increases in sales and profits in very mature or declining markets, including turnaround situations. He is able to provide leadership for all levels of the organization and effectively manage change.
Mr. Smalley graduated with the top award in his engineering class and graduated from Honeywell’s internal Executive Management Program presented by Harvard Business School.
For a free phone consultation, Ray Smalley can be reached at 1-800-596-0351
(c) 2004 Ray Smalley, VenPlan LLC. All rights reserved.
The contents of this paper are copyrighted and, as such, may be used for personal use only. Duplication and/or commercial use of this material is expressly prohibited without written permission of the author.