Cash Flow Management – Surviving Shortfalls

Cash Flow – Your First Priority

A lot of business think of Forecasting Cash Flow last, but I would argue it should be first.  It is imperative to prepare cash flow projections for next year, next quarter and, if the business is on shaky ground, next week. An accurate cash flow projection can alert the business owner to trouble well before it strikes and allow time for planned corrections.  Cash flow planning must happen first so that corrections can be identified.  Without a plan, management can only implement “knee jerk reactions” and not real solutions.  As difficult as it is for a business owner to prepare projections, it’s one of the most important things one can do.  Projections rank next to business plans and mission statements among things a business must do to plan for the future.  Here are some thoughts on cash flow planning:

  • Cash flow plans are not glimpses into the future. They are educated guesses that balance a number of factors, including the business’s customers’ payment histories, the owner’s own thoroughness at identifying upcoming expenditures, and the business’s vendors’ patience. The business owner needs to watch out for assuming without justification that: receivables will continue coming in at the same rate they have recently; that payables can be extended as far as they have in the past; that expenses such as capital improvements, loan interest and principal payments are included; that seasonal sales fluctuations have been accounted for.
  • I always start the cash flow projection by adding cash on hand at the beginning of the period with other cash to be received from various sources. It’s a process of gathering information from salespeople, service representatives, collections, credit workers and your finance department. In all cases, I have found that the same question is asked: How much cash in the form of customer payments, interest earnings, service fees, partial collections of bad debts, and other sources are we going to get in, and when?
  • The second part of making accurate cash flow projections is detailed knowledge of amounts and dates of upcoming cash outlays. That means not only knowing when each penny will be spent, but on what. Have a line item on each projection for every significant outlay, including rent, inventory (when purchased for cash), salaries and wages, sales and other taxes withheld or payable, benefits paid, equipment purchased for cash, professional fees, utilities, office supplies, debt payments, advertising, vehicle and equipment maintenance and fuel, and cash dividends.
  • Free Cash Flow = Net Cash Flow From Operations – Capital Expenditures where Net Cash Flow from Operations comes from the Statement of Cash Flows and an increase in capital expenditures comes from the balance sheet. If you look at free cash flow across several years of firm data and it is growing, that usually means that a growth in earnings is on the horizon for the firm. Firms with growing free cash flows are doing something, or many somethings, right. They may be enjoying growth in revenue. They may be efficiently managing their assets. They may be paying down their debt. They may be reducing their costs. If free cash flow is declining over a number of time periods, there may be dark clouds on the horizon for the company. Firms with declining free cash flow can expect a decline in earnings growth and worse. They may have to take on increasing levels of debt and may experience declining liquidity.

Improving Receivables

If business got paid for sales the instant they made them, there would never be a cash flow problem. Unfortunately, that doesn’t happen, but one of the first ways to improve cash flow is by managing the receivables. The basic idea is to improve the speed of turning materials and supplies into products, inventory into receivables, and receivables into cash. Here are specific techniques I have used for doing this:

  • Offer discounts to customers who pay their bills rapidly.
  • Ask customers to make deposit payments at the time orders are taken.
  • Require credit checks on all new non-cash customers.
  • Get rid of old, outdated inventory for whatever you can get.
  • Issue invoices promptly and follow up immediately if payments are slow in coming.
  • Track accounts receivable to identify and avoid slow-paying customers. Instituting a policy of cash on delivery (c.o.d.) is an alternative to refusing to do business with slow-paying customers.

Managing Payables

  • Top-line sales can conceal a lot of problems-sometimes too well. Especially when managing a growing company, be sure to watch expenses carefully. Don’t be lulled into complacency by simply expanding sales. Any time and any place you see expenses growing faster than sales, examine costs carefully to find places to cut or control them. Here are some more tips for using cash wisely:
  • Take full advantage of creditor payment terms. If a payment is due in 30 days, don’t pay it in 15 days.
  • Use electronic funds transfer to make payments on the last day they are due. You will remain current with suppliers while retaining use of your funds as long as possible.
  • Be pro-active and communicate with your suppliers so they know your financial situation. I can’t stress the PRO-ACTIVE enough.  If you ever need to delay a payment, you’ll need their trust and understanding.  Be sure to tell them when they can expect payment based upon a conservative plan and then be sure to achieve it.  Vendors will appreciate the contact BEFORE they see the problem.
  • Carefully consider vendors’ offers of discounts for earlier payments. These can amount to expensive loans to your suppliers, or they may provide you with a chance to reduce overall costs. The devil is in the details.
  • Don’t always focus on the lowest price when choosing suppliers. Sometimes more flexible payment terms can improve your cash flow more than a bargain-basement price.

Surviving Shortfalls 

Sooner or later, business will be in a situation where there is a lack of cash to pay the company bills. This doesn’t mean they are a failure as a businessperson-you’re a normal entrepreneur who can’t perfectly predict the future. And there are normal, everyday business practices that can help manage the shortfall.  The key to managing cash shortfalls is to become aware of the problem as early and as accurately as possible. Banks are wary of borrowers who have to have money today. They’d much prefer lending to you before you need it, preferably months before. When the reason the owner is caught short is that no plan was made, a banker is not going to be very interested in helping out.  Here are some helpful suggestions:

  • I like to assume from the beginning that someday there will be a shortage of cash and arrange for a line of credit at a bank. This allows me to borrow money up to a preset limit any time I need it. Since it’s far easier to borrow when you don’t need it, arranging a credit line before being short is vital.
  • If bankers won’t help, turn next to the suppliers. Suppliers are more interested in keeping your company going than a banker, and they probably know more about the business. You can often get extended terms from suppliers that amount to a hefty, low-cost loan just by asking. That’s especially true if the company has been a good customer in the past and kept them informed about their financial situation.
  • Consider using factors. These are financial service businesses that can pay today for receivables that may not otherwise be able to collect on for weeks or months. They charge as much as 15 percent less than what would otherwise, since factors demand a discount, but the company will eliminate the hassle of collecting and be able to fund current operations without borrowing.
  • Ask the best customers to accelerate payments. Explain the situation and, if necessary, offer a discount of a percentage point or two from the bill. You should also go after your worst customers-those whose invoices are more than 90 days past due. Offer them a steeper discount if they pay today.
  • Can the company raise cash by selling and leasing back assets such as machinery, equipment, computers, phone systems and even office furniture. Leasing companies may be willing to perform the transactions. It’s not cheap, however, and the asset may be lost if lease payments are missed.
  • Choose the bills to pay carefully. Don’t just pay the smallest ones and let the rest slide. Make payroll first-unpaid employees will soon be ex-employees. Pay crucial suppliers next. Ask the rest if a payment can be skipped or make a partial payment.

If you liked this thought, you may enjoy viewing the free video The Financials – Managing Your Business Session 2 Financial Concept Uses.

Copyright ©JMT 2021

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