Optimizing Cash Flow: 7 Steps to Less Stress and a Better Business

Keep Cash Flowing Like Niagara Falls

It’s a simple truth: “Hope is not a strategy.” It’s true in so many fields of human endeavor, but none more than cash flow.  And with so many business owners relying on hope to avoid a cash flow crisis, it’s no wonder some businesses wind up in a place known for a very different saying; “Abandon all hope, ye who enter here.”

Even business owners and their CFOs or financial managers who know better than to “hope” for positive cash flow tend to believe that if a business is profitable, then the cash flow will be fine. They are unlikely to fare any better because the two concepts are fundamentally different: profitability is a simple comparison of revenue and expense; cash flow describes the sources and uses of cash, plus the movement of that cash over a period of time.

As a result, improving cash flow takes a deeper understanding of the business, some specific tools and constant vigilance. Let’s take a deeper look at seven tools that will help you understand, plan and improve your cash flow.

(1) Customer On-Boarding: Get Proactive

You’ve heard the old saying: “Until the customer pays, a sale looks a lot like a gift.”

Keeping your sales looking and acting more like sales and less like gifts requires a functional strategy for managing your Accounts Receivable and Accounts Payable cycles.

On the A/R side, proactive management begins with the evaluation of each new account. If you haven’t already set down a documented policy for establishing the creditworthiness of a new customer, you need to. Everything flows from this.

It’s tempting to allow sales people to use their own judgment in on-boarding new accounts, just as it’s tempting to bend or break the rules “just this once.” But it’s also a slippery slope — sometimes a long and painful one. Get serious about this. At a minimum, your standard application for new accounts should contain your terms and conditions, a credit reference sheet and a request for contact information for key financial personnel.

Actually checking the credit references should be standard procedure, especially the bank reference. In today’s fast and loose economy, even companies that struggle to pay their bills can generally come up with several references that will vouch for their creditworthiness. This makes digging deeper all that much more imperative.

Verify bank balances and length of accounts opened. Check their number of  bounced checks (NSFs). Being systematic about checking the details will help you avoid disappointment later on.

Make great A/R policies part of your company culture by writing them down — create written policies that govern each step of the customer on-boarding, invoicing and collections process.

(2) Day to Day: Make A/R Work For You

With sound policies in place, keep your eye on your company’s A/R collections practices. A good collections policy has the following attributes:

Consistency. It’s either method or madness. Are your invoices followed up on in a manner that is both consistent and documented? For example, 1st notice by email after seven days; 2nd by phone call after 15 days; 3rd by credit hold after 30 days. Whatever process you establish, follow it.

Commitment. When collection problems appear, always get the customer to commit to a schedule or timeline. The payments can be small at first. But getting them back to the cycle of paying your company on a regular basis is imperative. Creditors that are heard from are creditors that get paid.

Discipline. Your charges should be in the terms and conditions you extended originally. Assess these charges and late payment fees for past due balances. Just do it.

Involvement. Get the service team involved. After all, it’s their customer. They have the relationship; they get the commissions; they have a vested interest in collecting the A/R. In addition, paying commissions and bonuses on paid sales only is a policy that focuses on a team-based and company-first culture.

(3) Day to Day A/P: Pile on the Days Payable

You’ve asked your customers for detailed credit information; mirror those steps for your own vendors. Set up a purchasing program that exudes professionalism while providing your suppliers with every bit of information they need to establish your company’s creditworthiness. The quality of your effort can make the difference between getting more favorable terms and being placed on pre-payment!

We strongly suggest developing a professional-looking credit package for potential suppliers that can be accessed at a moment’s notice. Your package should contain your credit reference sheet, including each of the following:

  1. Bank and trade references
  2. Dun & Bradstreet number
  3. Key company personnel
  4. Federal Employer Identification Number (FEIN)
  5. Completed W-9
  6. Sales Tax Exemption Certificate

Next, draft a brief policy statement that details your expectations of suppliers. Tell vendors precisely what you are asking for in terms of delivery, invoicing requirements, price discrepancies, order confirmations and any other item you deem critical to timely purchases.

Finally, keep close track of your reputation. A sound purchasing program also requires your company’s credit rating to be monitored though the major bureaus with corrective action taken if negative conditions appear.

(4) Amplify the Benefit of Good A/R and A/P Practices

When sound policies are in place, put them to the test. Ask yourself the following questions to rein in cash flow problems before they start:

  • Do you extend the same terms to all customers?
  • Do you offer early payment discounts?
  • Are your receivable terms typically longer than payable terms?
  • Do you ever push vendors about for extended terms?

If you answered “no” to any of these questions, you’re likely missing an opportunity to positively affect your cash flow.

Proactive management means offering customers an incentive for early payment – maybe a 2% to 3% discount, provided they pay within 15 days. Yes, of course you are giving up a sliver of profit if they take advantage of the discount. But time is money. What you sacrifice on the top line will be outweighed by improved cash flow.  And don’t forget the savings from time no longer spent by your collections staff making collection calls.

Likewise, consider using credit cards to extend the payment cycle for expenses and purchases. Suppliers may charge a nominal fee for this, but it can add 20 to 50 days to the payment cycle. That can unlock a huge amount of cash (and earn points you can redeem for other needs).

Finally on the payables side, identify your best vendor relationships and ask them for another 15 to 20 days to pay. If you have established a track record of on-time payments, they will know you’re good for it.

(5) Turn the Crank Faster: Alternative Solutions to Receiving Payments

Now, regarding payment. Still accepting paper checks? There are a number of alternatives to paper that can speed up deposits and shave days off of your A/R cycle.  A check scanner can accelerate deposits, but consider a completely different method to really turbo-charge your deposits.

Consider switching to an invoicing or accounting program that allows customers to click on a link to pay an emailed invoice. This way, they can schedule payment via direct deposit, ACH or credit card. Offer a customer portal on your website that accepts bank or credit card payments. An efficient electronic payment ability also means that you can place any late-payer on pre-pay (or COD) terms. Make that a firm rule, but make it simple for the customer too. Mobile credit card terminals, web-based payment portals, recurring ACH, and auto-debit systems are easy to set up reliable and assure faster payments than any other means.

(6) Other Points of Pain: Check Your Debt Levels

Your income statement can also provide some insight. If it shows reasonably high profits but you’re always pressed for cash, it’s a sign you have too much debt. You can verify this by calculating the following ratios:

  1. Debt to Asset Ratio = (Total debt / Total assets)
  2. Debt to Income Ratio = (Annual debt service payments / Total income)

If your company’s ratios exceed 40% in either case, consider asking your creditors for more favorable loan terms, such as a lower interest rate, longer repayment terms or interest only payments. The key here is advanced and proactive communication with your creditors. Lenders will appreciate the opportunity to work with you before re-payment becomes a problem (or causes other problems).

(7) Forecasting: Prevention Requires Prediction

Accurate forecasting is a function of the frequency with which both A/R and A/P are reviewed by your team. If you review cash flow metrics less often than twice a month, you’re missing an opportunity to avoid a cash crunch before it happens.

The old adage holds true: “What gets measured, gets changed.” And what gets measured depends on the Key Performance Indicators (KPIs) you deem critically important. Pick three to four cash flow KPIs, set benchmarks and be vigilant.

Here are three cash-flow KPIs that should be a part of every company’s bi-weekly review:

  1. Days Sales Outstanding (DSO) = (AR / last 12 months of sales x 365)
  2. Days Payable Outstanding (DPO) = (AP / last 12 months of purchases x 365)
  3. Days Sales in Inventory (DSI) = (Inventory / last 12 months COGS x 365)

Together these three metrics form the “Cash Cycle” in your business.  The key relationship is obvious – if you can float your bills longer than your customers (DPO > DSO), cash will accumulate in your business.  And, for a product-intensive business, if you can avoid holding that extra cash in Inventory, then it can be used to grow the business in other ways.

If DPO is less than DSO, then cash is flowing out the door. The bigger the difference, the faster cash is flowing either positively or negatively.

Make it a habit to examine these KPIs at least bi-weekly. Chart them out so you can see the variation. Then get everyone involved: Accurate forecasting requires departments to collaborate and share information. When addressed in a timely and systematic fashion, it facilitates planning for anticipated cash crunches so you can address the problem before it reaches you.

Too often businesses fail to look ahead using the proper instruments and tools for the task. Looking only at the P&L statement, they wonder why they have no cash. The truth is, history cannot be relied upon as a valid guide for the future or even the present!

A wise manager will solicit input from all departments, so he or she can forecast when a cash crunch is coming. It is much more difficult to navigate a cash flow problem once you are in its grip.

Better Cash Flow, Better Business

Why is avoiding a crunch so critical? Many of the reasons have to do with human nature. Employees, suppliers and customer are adept at detecting duress. People get nervous. In lieu of cash, rumors flow. So besides the obvious problems of missing critical payments (like rent or payroll), the problems quickly compound both inside and outside the business.

It hardly bears repeating, but “Cash is king.” Proper cash management will pay off not only in reducing your stress, but also in important operational metrics, like preferred pricing and terms, bigger discounts and improved profits. Develop your strategies for cash flow management and follow them rigorously. Use the right ratios and metrics to project cash from actual, reliable, data.

The key to preventing a cash crisis is to plan, implement, manage, and predict.

Dedicated to your (cash positive) success, Steve MacPherson

photo credit: niagara falls via photopin (license)

4 Comments
  1. Great article! I have posted it on linked in. Although I am biased I see a lot value in your suggestion to turn the crank faster. There is a lot of new technology around invoicing automation or payment automation with fraud protection. These tools can increase efficiency and reduce labor costs in the process. Thank you for sharing.

    • Thanks Joe!
      Great to see you, and thanks for sharing with your connections on Linkedin.
      WellsFargo has some great tools for cash flow that we should have highlighted. Feel free to promote a few of those here! (Lockbox, check scanners, Billpay, QuickBooks direct connect, etc… all good stuff!)

      DTW

  2. As usual good advice David!

    • Thanks JP:
      Of course putting these things into action is the real challenge!

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David, Steve and Mac are looking forward to speaking with you!