The Weekly Cash-Flow Planner
Knowing how to anticipate and control your cash flow will tell you how to run your company
Cold, hard cash. It buys discounts with suppliers, loans from bankers, leverage with customers, payroll, and stockholder dividends -- not to mention peace of mind. Especially during these iffy economic times, cash is king. Little wonder, then, that the cash-flow forecast has become an indispensable planning tool to company owners like Jim Pritchett and Dana Sellers, who founded Trinity Computing Systems, in Houston, in 1981.
Trinity installs networked personal computers in hospitals so doctors and nurses can keep track of patient data more efficiently. At the time of its founding, the company was on the leading edge of local-area-network technology. Revenues rose quickly to $6.5 million in the company's first six years, and twice it earned a place on the Inc. 500. But Trinity's line of business presented a variety of demands on cash flow that had to be met if the growth was to continue.
For starters, Trinity's systems sold for an average of $200,000, and hospitals were notoriously slow payers. Worse still, customers paid in installments, withholding the last 25% until all the bugs had been worked out of their systems and users were fully trained. That would often take months, and Trinity's profit was tied up in the last payment. "Our revenues were huge peaks and valleys," Pritchett says.
By 1985 Pritchett was running the company by the seat of his pants, and it showed. "We were crisis managers," he recalls. "The controller would go through a bunch of money and then ask what vendor we could put off paying. To find out, we'd have to bother technical staffers out in the field, who, 9 times out of 10, didn't have the answers at their fingertips." Kirby Attwell, a board member and investor, suggested that a weekly department-head meeting coupled with a cash-flow forecast might put the company on an even keel.
Pritchett gave it a try. Prior to each meeting, the controller would collect from each manager such vital information as product ship dates, inventory purchases, sales, installation schedules, and collection dates. That information permitted department heads to coordinate their respective resources to avert foreseeable cash droughts. Pritchett says being held accountable for resource expenditures on a weekly basis improved managers' record-keeping systems and helped clue all employees in to how their jobs affected the health of the company.
The cash-flow forecast quickly became a more important planning tool than the operating statement. In fact, the forecasts make it so easy to understand the status of the company that Pritchett shows them to bankers and vendors to negotiate better loans and payment terms.
While many companies might track cash in and cash out on a monthly basis, Pritchett does so weekly, so few errors go unchecked. Over the years he has expanded his Lotus 1-2-3 cash-flow forecasting system to eight pages of detailed expense and revenues data. As a result, the installation department's productivity has improved, collections have dropped from 120 days to 80 days, and the sales staff has become much better at negotiating discount structures and payment plans.
In 1991 Pritchett sold the main Trinity product line to DuPont for an undisclosed sum. "Without the cash-flow forecast, I doubt we would have had a product line worth selling," claims Pritchett, who now, as sales manager for his product line for DuPont, rarely has to worry about cash.
On the following pages, Pritchett explains how he would use the information to avert potential hiccups in a company's cash flow and how using the forecast has made him a better manager.* * *
Assessing the Risk
"We divide sales into two categories: prospective purchase orders and prospective maintenance. Prospective POs are iffy compared with the more predictable service contracts, which are renewed every year with existing accounts, so we assign them different risk factors. Then we develop best-case, middle-case, and worst-case scenarios. In the worst-case scenario we make no new sales, and we're installing backlog orders but not collecting any receivables. In the best-case forecast, we hit the numbers just as department managers estimated. In our middle-case scenario we fill all the backlog orders, but we're missing half the prospective purchase orders. That's the one we end up using most. We developed the scenarios because the head of sales was consistently off on his estimates. Typically, our sales cycle was 18 months. When we'd close a sale on a $200,000 system, psychologically we'd count on the whole amount. But we'd actually get only a 25% down payment. The rest wouldn't come in for a while, after successful installment and customer training. So we could enter only $50,000 in our forecast. Seeing that in black and white impressed on the sales force the importance of getting bigger down payments."
"Once we put a system in, we can look forward to annually renewing service contracts that tend to be fairly predictable every month. As we've grown, the maintenance baseline has become bigger, evening out the peaks and valleys of earlier years' revenues. As customers start buying upgrades, accounts become more profitable because we have a lower cost of sale and lower training costs."
Change in Cash
"This is the difference between what you have coming in and what you have going out. By October 29 we'd be going into a real dry spell, according to the worst-case scenario. As a result, I'd try to cut travel. I'd go to an account on backlog (Account 18), and offer it a discount to accelerate its payment due on November 19. Just about anyone who runs a business is always trying to do those things, but a cash-flow forecast focuses your efforts."
"Filling our backlog orders is the responsibility of our installation manager, my founding partner, Dana Sellers. It's much easier to control the backlog cash flow than cash flow from prospective purchase orders, because backlog flow depends wholly on our scheduling efficiency and productivity. We'll consider bumping a customer up on our installation schedule if that customer agrees to cut a check for us earlier than planned. Before we used cash-flow projections, we scheduled work on a first-in, first-out basis; now we take cash-flow needs into account.
"For instance, our Account 18 has agreed to pay us 50% of the sale, or $125,000, at a certain point in the installation. Looking at this cash-flow forecast, it looks as if we expect our installation resources to be tied up on Account 15, so we schedule Account 18's installation later. At another time, depending on our cash needs, I might have looked for a way to juggle those two jobs simultaneously, to bring in more revenues earlier."* * *
Instant Daily Battle Plans
"[A negative weekly ending balance for November 12] means we won't have any money that week. When I see that, I go to my list of prospects and scan what happened the week before and what's happening the week after. In this case, the week of November 19 we are expecting a $125,000 payment from Account 18. If we miss the installment milestone we need to meet to get that payment, we're in a little trouble that week but big trouble the following week, November 26. All of a sudden, Account 18 has become very critical to our cash flow. Not only am I making sure that $125,000 is golden, but I'm also looking for any payables I can let slide. I notice November 12 is a payroll week, and I have to make sure I don't get caught short."
Prospective Purchase Orders' Cost of Goods Sold
"You'll notice here [in the hypothetical case] that if prospective sales are closed on schedule, we'll have a marked increase in vendor bills due in December. We may want to call vendors and say, 'Look, if we stay on track, we should be closing some important sales this quarter. Can we stretch payments until January?' At the end of the year vendors will want to close out the books with those sales on record. Before the cash-flow forecast, we'd have bought as cheaply as we could and gotten early-payment discounts. Now we can ask if we can put less money down and push our payments into the future, to match incoming money more closely."
"The cash-flow forecast encourages us to pay more attention to how we service our accounts. Hospitals usually pay us in 120 days -- part of the amount when we make the sale, part when we install it, and the rest when it's up and running. Often customers won't make that last payment until we fix a glitch. The cash-flow forecast helps impress on our installers the importance of doing a quality job the first time out. Under our usual 25%-50%-25% payment structure, most or all of our profit is in that last payment. The cash-flow forecast showed us the wisdom of offering discounts to customers who are willing to change their payment terms to 35%-50%-15% or even 50%-50%-0%."
"Between December 10 and January 20 it's difficult to do business because people are often away. As early as October I start to put pressure on people to speed up billings. I also cut back on travel expenses. The schedule calls for us to pay a $25,000 letter of credit on December 24. I'd try to negotiate to pay in January. The important thing is to start the gears churning in October to prevent a cash crisis."
"It quickly became apparent to us after setting up this system that when you spend the money is as important as how much money you spend and what the payment terms are. For instance, to fill one order, you need to buy from five vendors. We used to order components the day the sale came in. Well, maybe one of the five components wouldn't arrive for 75 days. Now we delay ordering the four components so their arrival coincides with the 75-day delivery schedule of the fifth one. That really helps free up cash."