As featured in Lumber Co-operator.
Cash Flow Management Can Kill A Business…or Make It Thrive.
“Poor cash flow management is the primary reason for a vast proportion of business failures. Many profitable companies find that they are, for all practical purposes, insolvent – simply because of uneven cash flow.”
That's a quote from Josh Hall’s essay “Top Five Reasons Why Businesses Fail”.
Does it ring true for you?
In our business sector, it’s no secret that solid cash flow management practices are crucial, especially given the idiosyncratic nature of how our customers purchase and pay for building materials. Put ten successful LBM dealers in a room, and most would say that they have decent collections but would admit that lack of cash flow is holding them back from their goals of legacy planning or new growth ambitions. They would also tell you that they sometimes feel the frustration of “being the bank” for their customers with chronically late payments keeping them from what matters most.
The Impacts of Cash Flow
Before we suggest best practices for managing A/R, note that these practices are focused on your balance sheet, not necessarily your P&L. If a dealer has strong sales, yet is not paid on time for goods sold, those sales are reflected on their balance sheet as A/R, rather than as cash. Too much non-current A/R is the sign of a business whose growth potential is being limited and is potentially a vulnerable business, if something happens and they need that cash.
Reasons for maintaining a healthy balance sheet reach beyond peace of mind or the need to maintain a contingency fund. If cash is not constricted, you can make vendor payments on time and keep up with maintenance and upgrades. Good cash flow also allows you to hire and retain quality staff, stock plenty of inventory, roll with dependable trucks, and invest in logistics and inventory control technology.
Here’s a comparison to highlight the impact of good cash flow. Company A, an organization with $15,000,000 annual sales, generates $1.2 million in sales in January, but collects just $1,000,000 net 30, allowing the remaining $200,000 to slide, say, 60+ days.
On paper, Company A seems to have a healthy topline, yet they are cash constricted. The inventory they sold has to be immediately replenished, but they are not getting paid on time for all of it.
By contrast, Company B collects all of their A/R (or >95% after bad debt). With cash on hand, they invest and grow. With a healthy balance sheet, they act like a $15,000,000 company, taking advantage of big buying opportunities. They never miss out on early-pay discounts with suppliers, and they have more availability on their credit line to make strategic investments, rather than using the 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
If Company A wants to be more like Company B, they have multiple ways they can transform delinquent A/R into healthy cash flow.
First, they can tighten their credit and A/R management processes by putting slow payers on COD, requiring that customers pay down delinquent balances before accessing additional credit, and assessing and collecting interest charges to compensate for late pays. This is a rejuvenation of sorts of how Company A manages credit. It takes time, discipline, and the willingness to confront customers to change their behavior.
A second option is a credit management company. A credit management company is not a factoring solution, but a supplement for your bank line of credit. There is no “hold back” of your money, and fees are typically less than credit card processing fees.
A credit management provider can pay you upfront for your sales and protect you from risk, and allow you to customize how the program works, such as which party manages collections. It also lets you offer extended terms and larger lines on a customer-by-customer basis, to help you grow sales.
If you have your sights set on growth, legacy or better quality of life, start with a clean balance sheet and high performing A/R. You owe it to yourself, your family, your employees, and your customers to bring discipline to your A/R, so you can realize the bounty of good cash flow.
Interested in learning more? Click here to read Killer Cash Flow Part II: HOw to Build the Cash Reserves You need to Guard Against the Next Downturn
About the AuthorMore Content by Scott Simpson