If you’re looking for a quick fix for cash-flow problems, good luck. But if you’re serious about making strategic changes, read on.
With revenue gains still something of a pipe dream for most businesses, owners are looking for ways to squeeze as much cash flow as possible out of their existing operations.
It's a simple enough formula: collect your receivables as fast as possible and slow down your payables without jeopardizing your relationship with suppliers.
Still, some companies are much better at it than others: Top-performing companies collected from customers 17 days more quickly than typical companies in 2009 and stretched payables by an additional 10 days, according to REL, a consultancy focused on improving cash flow and working capital and a division of the Hackett Group.
If you're just looking for a quick fix, you can extend your accounts payable period by using a credit card to pay suppliers. With a check, you only get a day or two of float – or the time between when someone deposits your check and when the amount is removed from your account. But if you pay with a credit card, your vendor gets paid and you don't have to pay the card down for several more weeks. Of course, you don't want to charge more than you can pay off in a month or you'll get slapped with some hefty interest charges.
That's a simple – and fairly short-sighted – solution. But if you're serious about improving cash flow, here are five tips.
1. Perform a Good Forecast
The first step is to get a good grip on where you cash flow currently stands and where it is likely to go in the future. Quite often small and mid-sized businesses aren't prepared for all the costs associated with growing quickly. More sales could mean more employees and a bigger inventory. That's money going out upfront. But when will it come back? "Too many companies get blindsided by unfavorable movements in cash flow that are predictable if they really sat down and thought through it," says Paul LaRock, a principal at consultancy Treasury Strategies in Chicago.
The forecast could be as simple as paper and pencil for the smallest company, but others will want to put together a more formal cash flow projection. A rolling 12-month forecast is the best practice for most companies. If you start mapping things out week by week, you'll see where to expect surges in expenses ahead of your big sales season and where several payments might come due all at once.
2. Evaluate Your Terms
If you're having trouble with cash flow, check to see how well your customer terms and supplier terms are balanced, recommends Analisa DeHaro, an associate principal with REL.
"If your average payable is 24 days and your average receivable is 47 days, that's 23 days that you have to float, which means you have to go out and get working capital," she says.
You'll want to look at the terms you're offering to customers and evaluate if they work for you and how your customers are performing to those terms. With suppliers, you want to see how their terms stack up against others in the marketplace. You might also discover that you're missing out on a discount if you were to pay even earlier. That might run counter to your goal of shortening that receivables-payables gap, but the money involved might be worth it.
3. Enforce Payment Discipline
In order to shorten your receivables period, you'll need to have a good collection system in place. DeHaro says you should ask yourself:
Keep in mind that these are not only ways to improve how quickly you get paid, but your customer service as well.
"If you buy something and something is wrong with the invoice, and it takes them a long time to resolve it, it makes you have a little angst and make them seem more difficult to work with," DeHaro observes.
And keeping on top of your problem children payers isn't just about looking at the 90-days outstanding column in your account receivables, but even your 61-days and 31-days column, says LaRock. "You can't let things ride the extra few weeks like you could in a healthy economy," he says.
Enforcing payment discipline should also be part of your payables operations. A sloppy AP department might miss out on discounts and habitually paying late could hurt you the next time a contract comes up for renewal. By paying on time, you can build a relationship and negotiate for future discounts or payment terms better suited to your business cycle.
4. Segment Your Customers, Suppliers and Inventory
You probably won't get too far if you try to tackle your cash flow as a whole. You're better off segmenting suppliers, customers and inventory.
When looking at your inventory, you want to observe the volatility of sales. Do you have too much cash tied up in products that sell only sporadically? Would that money be better off used in your "bread and butter" items that turnover more quickly? "You might end up having tons of money tied up in inventory without actually meeting your customers' needs," says DeHaro.
When breaking down your suppliers, you want to separate them into your regular suppliers versus your one-off buys. With your strategic suppliers, you'll have a better chance of negotiating better terms and discounts.
Perhaps most importantly, you should take a close look at your customers. Who really is a "key customer?" Just because your sales department thinks they're important – i.e. they generate a lot of revenue – that doesn't mean it's a profitable account. Norm Brodsky wrote last year about one business whose biggest account was actually a big money loser, ultimately adding to its cash flow woes. The solution isn't necessarily to cut that account, but to approach the customer with the situation.
You might also find that your biggest customers are your worst payers. You'll want to put together a strategy on how to approach them. If a customer typically pays in 60 days, you should gently reach out to it after 30. Additionally, there might be a good reason why the client ends up paying so late, like frequent disputes on invoices. "Once you identify the problem, you can fix it and present a better service to your client," DeHaro says.
5. Make it a Companywide Priority
If improving cash flow is a priority, make sure all of your employees understand that. Remember that your employees will be motivated by the targets you set for them. Obviously, collectors should have collection targets. But even your sales staff should be on board. If a salesperson only has a revenue goal, he or she will work to meet it, regardless of whether the invoices are paid on time or in full. Instead, institute a policy where, if something is written off, the revenue is backed out of commissions.
"If employees have a target, that's what they focus on," DeHaro says. "Make sure management teams support working capital objectives."
MATT QUINN contributes to the Wall Street Journal's corporate finance blog. He has also written extensively about banking and corporate finance for publications including Inc., American Banker, and Financial Week. He lives in Brooklyn, New York.