Guest commentary: Cash flow management
Even the best accounting methods can mask the full negative effects of poor cash flow. In fact, it’s not unusual to find companies that seem to be profitable, but a deeper look shows they are effectively insolvent for reasons of uneven cash flow.
Consider a mid-market company that books $25 million in annual revenue, or around $2 million each month. Just 15% of receivables that are 30+ days out and 5% bad debt can put $400,000 at risk in any one month. That’s a serious amount of money even for a company that size. It not only deprives the business of the liquidity it needs to pay staff and operating expenses, but it also deprives the company of the cash needed to take advantage of early-pay discounts and good buying opportunities. Let’s take a closer look.
Anyone who has been involved in the building materials business knows that our customers’ purchase and payment patterns are highly idiosyncratic. We put up with it, because we may know the customer personally, or we sympathize with the customer when a project goes belly-up due to unforeseen and unavoidable circumstances. That said, if you put a few successful building material dealers in a room, they would all likely agree on the following items: 1) Disciplined collections have been a key to their ongoing success, in up and down markets, no matter who owes you the money; 2) Strong cash flow allows them to offer great customer service and robust inventories; and 3) When they see other businesses stumble, it’s because they fell into the trap of financing their customers when they fall behind (by “being the bank”), sometimes letting accounts go out 60, 90 or 120 days, which only deprives their own business of needed cash flow as a result.
CASH FLOW: WHAT IT AFFECTS
When examining best practices to implement for managing your accounts receivable, note that the area of your business we are focusing on is your balance sheet. The profit and loss statement, known as a P&L, will eventually be affected by a poor balance sheet, but the more immediate effect of poor A/R shows up on your balance sheet. Fact is, if you are a dealer with strong sales, but you are not paid promptly for them (or not at all), that’s a sign of an unhealthy business, no matter what your P&L seems to be telling you.
What are the compelling reasons for maintaining a healthy balance sheet? It reaches way beyond the emotional satisfaction of seeing a strong bank balance in your daily reports. If your cash is restricted, you can’t make payments to vendors on time, and you may end up paying more for your products than you had planned, or miss preferential pricing opportunities that require spot buys. Without cash, you may defer upkeep or upgrades on your buildings and equipment. Plus, good cash flow also allows you to hire and retain top-notch staff, stock plenty of inventory, roll with dependable trucks, and invest in the latest technology to manage your logistics and inventory. Where would your business be without those features?
Here’s a comparison to highlight the impact of good cash flow. Let’s say that ABCD Lumber (an imaginary company) with $15,000,000 in annual sales, generates $1.2 million in sales in January, but collects just $1 million in net, allowing the remaining $200,000 to slide, say, 60-plus days.
ABCD Lumber seems to be healthy, right? It has a great top-line of revenues, but it has far too much in receivables that result in a cash constricted situation. After all, everything that ABCD Lumber sells (yet has not been paid for) has to be restocked, at their cost. So, they need to get paid, and promptly, for everything they sell.
By contrast, EFG Supply (another imaginary company) collects all of their A/R (or >95% after bad debt). With cash on hand, they invest and grow. Their balance sheet is healthy, and they act like a $15,000,000 company, taking advantage of opportunities enabled by having cash on hand. EFG Supply won’t miss out on early-pay discounts with vendors, and this good cash position has freed up their credit line, so they have more of it to make strategic investments. They are not using their credit line to supplement A/R. They also recognize that these are the very investments that separate which businesses prevail, and which ones risk spiraling into insolvency.
HOW TO FIX IT
How can ABCD Lumber act more like EFG Supply? It’s simple: They must collect the amounts due 1) without factoring the debt, and 2) without driving away customers with collections practices that are off-putting.
For starters, the A/R practices have to be disciplined and consistent. This can be done in two ways: 1) internally and 2) through a third party.
Internally, they need to rejuvenate the A/R process by A) Putting slow payers on COD; B) Requiring that customers pay down delinquent balances before accessing additional credit; and C) Assessing and collecting interest charges to compensate for late pays.
Externally, consider engaging a third-party credit management company. When people hear that term, they think of expensive debt factoring, but a credit management is not a factoring solution. Think of it more like a supplement to your bank line of credit. You are paid up front for all your sales, and often the credit management company can manage your collections as well. Fees for these kinds of providers are comparable to, or less than, what you are paying now in credit card processing fees. A credit management provider offers cash flow and risk protection, while providing great customer service toolsets. Typically, you design the treatment and terms of your collection program; you control the treatment of your customers.
An enduring legacy of success for your business starts with a clean balance sheet and high-performing A/R. You have an obligation to yourself, your family, your employees, and your customers to bring best practices to your A/R, because that’s how you realize the full benefit of good cash flow.
Scott Simpson is president and CEO of BlueTarp Financial, a leading provider of credit management services to the building supply industry.