Almost every business owner gets into trouble with cash flow at some point. Often, the problem is unavoidable and unforeseeable. A long-time customer goes bankrupt, an economic recession hits, a key customer buys less and pays more slowly, essential machinery breaks down and shipment dates slip, an acquisition does not meet projections or a seasonal sales valley is greater than expected.
If you are a business owner, you will likely experience cash flow crises from time to time, and you will need to deal with them quickly, effectively and creatively. Nobody knows your company as well as you. Only you can determine which expenses can be reduced or eliminated. Only you can pinpoint which resources that can be tapped for cash.
Here are steps that have been taken by other business owners to survive cash flow crises. They are listed in order of immediacy of impact. Each may be helpful to you in dealing with your own cash crunches.
1. Stop non-critical capital projects – Are you spending money today to develop new products or services that might yield a return in the future? Unless the return on investment is immediate and assured, consider curbing these expenditures when a real cash flow crisis hits. This is not the time to take big risks. Focus on building, maintaining and improving your proven products or services. Explore less risky projects such as new ways to sell or developing new markets for your proven products.
2. Squeeze cash from inventory – Inventory can tie up a significant amount of cash. Review your inventory needs. Raise cash by selling obsolete, discontinued or damaged inventory at clearance prices. Reduce slow moving inventory to very low quantities or eliminate these units altogether. Better yet, get your vendor to “drop-ship” directly to your customer on such items. For frequently used inventory items, negotiate a price discount for volume purchases and look into longer-term contracts to fix future prices. Smart purchasing can substantially increase your pretax profit margin. For example, if your pretax margin is 10 percent and your gross profit margin is 40 percent, a 3 percent savings on inventory purchases can represent a 30 percent increase in net profits (i.e. net profits rise from 10 percent to 13 percent). If your business does $1,000,000 in revenue annually, profits will rise by $30,000!
3. Maximize collection rates after the sale – First, every company should have a sound, sensible credit policy and an effective collection procedure. Both should be enforced consistently at all times. Doing so will keep collection losses to a minimum, especially during difficult economic times when collection losses always rise. Second, when it comes to the collection of trade receivables, the squeaky wheel really does get the grease. At the very least, be sure you are top of mind with the payables clerk. Third, if an item is disputed, address it immediately. Find out the exact nature of the problem and take steps to remedy the situation. Fourth, if a customer is in financial difficulty and the amount due is sizable, try to get a formal note executed for the full amount due with a specific repayment schedule and interest rate. For more information on credit polity and collection procedures, see the article titled Sound Credit and Trade Receivable Collection Policies and Procedures in this issue.
4. Reduce labor costs – Identify and eliminate all non-critical overhead. Lower the number of employees through attrition. Reduce fringe benefit programs and consider hiring temporary labor to eliminate the expense of benefits for non-key positions. Defer salary increases and bonuses. If permitted, hold back on making retirement contributions, particularly optional matching contributions. For action that is more drastic … consider across-the-board salary reductions of 10 percent, until cash flow improves. Your employees will not like it, but the burden is shared by all and it is more palatable than layoffs. Stress that it’s only an interim measure and explains why it’s necessary, e.g., the loss of a major customer. Don’t forget to include yourself in the 10 percent salary reduction and be sure you don’t violate any labor or employment contracts and state or federal laws.
5. Reduce interest expense and increase interest income - Often, interest expense can be reduced by simply making the effort. Use this article to find ways to raise cash – without borrowing and tax free – and apply the proceeds to reduce borrowed balances. Balances that remain should be assessed with an eye towards lowering the rate of interest. If you are carrying credit card balances, look into paying them off with a lower interest loan from a traditional lender. If you have notes at fixed rates of interest, find out if you can refinance them at lower rates. During recessions, interest rates will always fall. Make sure you take advantage of the lower rates. Watch for high built-in lease interest expense. When making a capital expenditure, always compare the rates and terms of lease options to those of traditional bank financing. To boost interest income, make sure you are getting the highest yield possible on any carried balances in checking or savings accounts. If you carry excess balances, contact your bank about a sweep account.
6. Speed up receipts and deposits – Cash flow can be improved by simply accelerating the speed with which customer purchase orders are turned into cash. To do: Chart the flow of the typical sale, or each type of sale, from order to cash collection. Include every step, including time when nothing is done. Now, look at each step to determine if changes can be made to speed up the process. Consider combining or eliminating steps all together. Solutions could be as simple as asking for payment at the time of order. Some buyers would actually prefer this to the paperwork involved with being invoiced. Consider accepting credit cards, offering automatic account debiting or setting up a lockbox with your bank. See Accelerating Cash Receipts with a Lockbox in this issue.
7. Refinance debt obligations – Lower the monthly payments of term-debt obligations by refinancing. This will free up cash for other uses. Do this by taking the remaining principal amount and spreading it out over a longer period. If necessary, raise the amount of principal to obtain tax-free cash today. Example: Ten years ago, you purchased the land and building which you occupy for $400,000. You financed $350,000 of the purchase at 9 percent on a 15-year note. You pay $10,687 per quarter in principal and interest. Your debt balance today is $171,000. Your property is worth $500,000 today. To reduce cash payments and obtain some tax-free cash, you could refinance $250,000 at 7 percent over another 15 years. You would pocket $79,000 ($250,000 minus $171,000) and your new quarterly payment would be $6,763 (a $3,924 savings per quarter). Your debt-to-equity ratio in this investment would still be a modest 1:1 ($250,000 debt / $250,000 equity).
8. Reduce Miscellaneous Expenses – Many small savings can add up. Increase deductibles on select insurance policies to lower the premiums. Lease equipment rather than purchase. Talk to your suppliers about extending payment terms. Re-bid your recurring services such as cell phone, telephone, Internet access, website hosting, maintenance, janitorial and cleaning, waste disposal, long distance, etc. Watch for high bank services fees. Eliminate wasted money for things such as overdraft or insufficient funds charges. Get your banker to give you time to correct an overdraft before a charge is incurred, or set up a line of credit that will automatically cover them. Of course, you could do it the old fashioned way – know the balance in your account and don’t write checks for more than is in the account.
9. Consider downsizing to become more profitable – Many business owners are caught up in the bigger is better mentality. Look at your company’s performance. If profit margins are thin, re-assess your goals and make profit a priority. Begin by eliminating low profit margin products and services. This may allow you to reduce staff, facility size, occupancy expenses and overhead. Smaller may be better…and much less risky if you can deliver consistently healthy profits. Cash flow will improve and your borrowing needs will decline.
10. Retain current income by taking care of your established customers – Studies show that it is far less expensive to keep a customer than to secure a new one. Do all that you can to make sure that you don’t lose a good customer. You have a built-in advantage over your competitors who are working hard to lure them away. The battle will be won or lost largely based on relationship. Invest in your relationships with your customers. Start with the customers that purchase the most from you. Find out how happy they are with the goods or services you provide, and then seek to improve. Follow up and monitor the progress.
11. Analyze whether costs can be saved by outsourcing a job or service – Outsourcing was the management buzzword of the 1990′s, but it makes real sense. Look at your operations and identify activities, services or functions that you perform in-house now but could possibly be provided by an outside company or contractor. Of particular focus should be persons or assets that are underutilized. Accepted management theory says that a company should focus on their “core competencies.” Consider what yours are and list them. Focus on what is unique to you and your company and what allows you to win business over your competitors. Those things that are not on your list may be candidates for outsourcing.
12. Pick the low hanging fruit - Ask your customers, vendors, bankers, insurance agents and friends for customer referrals. A warm, qualified lead is many times more valuable than a cold prospect. Satisfied customers will appreciate the inquiry and gladly refer others to you. There is not a cheaper marketing program.
13. Don’t let your cash problems get in the way of your service to customers – Nothing is more important than the service you provide to your customers. Product quality, delivery schedules and service standards must be maintained — especially when your customer might be going through their own difficult times. When you are struggling, noticeable changes in the way you do business could alienate customers and reduce orders at a most inopportune time, causing you to lose customers when you need them most.
14. Sell more to existing customers – Often a significant amount of time and effort is spent courting new customers. Consider focusing on selling more products or services to persons or entities with which you already have a relationship – your existing customers. In the process, you will likely cover the first priority of keeping your current customers. Consider curtailing your expensive campaign to attract new customers and focus your energy on multiplying business with current customers. Get to know them in depth and find new ways to serve them.
15. Don’t take your cash flow problems out on your customers – Be careful not to suddenly and radically change your credit or collection policies. The smart way to manage is to have a fair but firm credit policy that is consistently executed over time. During cash problems, take care not to hurt a relationship. Instead, raise badly needed cash by offering discounts to settle troubled receivables and use some of the strategies presented in the two articles the appear in this issue, Sound Credit and Trade Receivable Collection Policies and Procedures and Philosophy of Trade Receivables Collection.
16. Resist the tendency to relax credit standards to get sales – Don’t bend your credit policies to book sales that may not be collected. Simple probability theory analysis can be helpful. For example, if you sold a $100,000 order today to ABC Co. and you had 100 percent confidence that you would be paid, consider the sale to be worth $100,000 cash. Now, if you sell the same amount to XYZ Corp. and you think the probability of being paid is 75 percent, then expect to receive $75,000. Is this acceptable? Keep in mind as well that if your company’s profit margin is 10 percent, a bad receivable of $10,000 represents $100,000 of lost revenue!
17. Reduce inventory shrinkage – As we have said, cost of goods sold is the largest expense in many companies. If you have an inventory shrinkage problem or you don’t track your shrinkage carefully, now might be the time to tighten control. First, develop a system for counting inventory at regular intervals. Compare the actual levels to those in your books and investigate any discrepancy. Second, be sure that everything you pay for is actually received. Be sure that: (a) the product was received in its entirety and in good condition or that the services were performed, (b) the math on the invoice is correctly computed, (c) any special charges are appropriate, (d) any available discount is taken, and (e) any sales tax is applicable and correct. It also might be a good idea to occasionally verify payments to vendors. How? Do as your auditors do. Send a written request to vendors for confirmation of the balance shown on their books for your company. Or, conduct a quicker check by simply telephoning select vendors to verify the balance of your accounts.
18. Good things come to those that plan – Prepare conservative monthly cash flow projections (both minimum and probable) for one year, and check and revise them each month so you know exactly where you stand on cash. Show projected beginning and ending cash balances for each month and identify any monthly deficits immediately. Then get to work on solving that deficit. Analyze monthly deviations in your budget forecasts versus actual results. Over time, your forecasting ability will improve, and you can plan to meet and finance any potential or expected cash flow deficits. If you wait until the need is reality, you could be risking the viability of your business and reducing your options for raising capital.
In conclusion, you don’t have to feel helpless when a cash flow pinch occurs. The options are almost as wide as your imagination. Use this article to give you ideas and action steps. Consider each and discuss them with your advisors. Most important, take action today and don’t let your pleasant disposition or ego get in the way of taking whatever unpleasant steps are necessary to get your company back in order. In the end, you and your employees will both benefit.
This article originally appeared in The Business Owner Journal, the periodical of choice for owners of small and midsize private businesses. All rights reserved, D.L. Perkins LLC. © 2012.
This publication is intended to provide general information on the subject matters covered. It is sold and distributed with the understanding that neither the publisher nor any distributor or advertiser is engaged in providing legal, tax, insurance, investment or other professional advice. The advice of a qualified professional should be sought before any reader applies a concept presented herein to his or her particular situation or business.
D.L. Perkins, LLC is solely responsible for this content.
