Cash Flow – The Life Blood of Your Company
By: Rich Kramarik
Most CEOs and business owners have heard the
term “Cash Flow.” Many will even say, “I manage the cash flow daily.” But, the
reality is that a very large number of these business executives don’t really
understand cash flow or strategies to manage cash. What we mean by this
statement is that executives don’t know the actions they can or should take to
forecast cash needs and uses, or actions they can take to improve a poor cash
One example is the CEO of an
engineering/design company who manages income or profit on a project-by-project
basis. He says that on every project he is meeting the projected project hours
forecasted, but the company is losing money. Why? Because on his project
expense forecast he does not include all the company overhead costs like the
large number of overtime hours paid to hourly employees at time-and-a-half.
These overtime payments along with other “incidental” expenses were adding up to
20% of project revenue. These costs not included in the project-by-project
budgets lead to a negative cash flow.
Another example is the CEO who does not
need to watch cash flow because, “…the bank account always has plenty of money
in it.” He pays ahead on bills and pays vendors as soon as he gets the
invoice. He gets paid in advance for work to be completed next month. Then one
day he goes to write a check and there is no money in the account. Why, because
his gut feeling on cash position is not in sync with the real cash position.
Just to be sure we are on the same page;
cash flow is essentially the movement of ALL money into and out of your
business. It's this cycle of total cash inflows vs. total cash outflows that
determine your business' solvency. Cash flow analysis involves examining the
components of your business that affect cash flow, such as accounts receivable,
inventory, accounts payable, investments and credit terms. By performing a cash
flow analysis on these separate components, you'll be able to more easily
identify cash flow problems and find ways to improve your cash flow.
Equally important to cash flow tracking is
cash flow forecasting. The cash flow forecast shows how cash is expected to
flow in and out of your business. For you, it's an important tool for cash flow
management, letting you know when your expenditures are too high or when you
might want to arrange short term investments to deal with a cash flow surplus.
As part of your business plan, a cash flow forecast will give you a much better
idea of how much capital investment your business may need.
Either your cash flow tracking or
forecasting can show you a cash gap. A cash flow gap occurs when your cash
inflows and cash outflows don't keep pace with each other, leaving your business
short of cash. This is an especially common problem for small businesses, where
cash outflows may often precede cash inflows. Many different expenses, from
purchasing materials necessary to do the work through licensing or permit fees,
may have to be paid out before the business gets paid for the work completed.
How do you close this cash flow gap and
keep your business solvent?
Keep a close eye on your cash flow, so you
can forecast potential cash flow problems and take steps to remedy them. Take
steps to shorten your cash flow conversion period, so your business can bring in
money faster. These steps may include:
1) Preparing customer invoices immediately
upon delivery of your goods or services to the customer. If you wait to prepare
your invoices at the end of the month, for example, you may be adding as many as
30 extra days to your cash flow conversion period! If you are already sending
invoices out within seven days of the work completing – reduce that time to 3
days and in some cases you will see an almost 30% increase in cash flow.
2) Monitoring your customers' use of credit
and adjusting their credit limits accordingly. If the amount owed is increasing
each month you may have a credit problem. Don’t wait for three to six months to
3) Offering customers a discount for paying
their invoices early. For instance, if your usual policy is to have payments due
in 30 days, offer a small discount such as 2 percent to customers who pay within
14 days. If you are already doing this, start writing contracts with payment
terms of 15 days – this is very common today.
4) Establishing a deposit policy for works
in progress. For example, if you deliver a service, such as software
development, training, or architectural services, you can adopt a policy that
customers pay a certain percentage of the total invoice up front before the job
begins. Likewise, don’t hesitate to build “milestone” or “progress” payments
into the contract.
5) Tracking your past-due accounts and
actively pursuing collections. Most accounting software programs let you easily
track past-due accounts, but you also need to have a clear process for pursuing
collections. Such a process might involve sending out a series of letters
letting your customer know that his or her account is past due and what steps
will follow if he or she does not pay, such as turning the account over to a
collection agency. A middle ground step may include a customer committed
payment schedule to “catch-up.”
6) Use “power invoices.” Invoices that say
due on receipt or due in 30 days are saying “pay when you get around to it” to
your customers. Worse yet are invoices or statements that age what is owed by
“current, 30 days, 60 days, 90 days.” By showing the aging you are saying you
are willing to carry what’s owed for that length of time. Instead write
invoices with a specific due date such as, “Due January 28, 2006.”
You have to have money coming in regularly
to maintain an adequate cash flow for your business, not just endlessly
streaming out. Forecasting and monitoring your cash flow and taking steps to
shorten your cash flow conversion period will go a long way toward eliminating
those dangerous cash flow gaps.
Cash Flow the Life Blood of Your Company
By: Rich Kramarik
This situation is a hardware sales and installation services
company with five million dollars in revenue with a solid recurring revenue
stream from a set of long standing customers. This CEO was struggling with her
cash situation for two reasons. First, her COO was convinced and had budgets
and contracts to back up the view that the sales and installation projects were
all profitable. Second, she didn’t have the money in the bank to pay the
bills. Each month she had to transfer money into the company from other
It didn’t take long to see some indicators of the problem when
we started looking at the financial statements, budgets and project records.
This was something this CEO was not doing. We found that the COO was pricing
product at a point he thought he needed to in order to win the business. On
average that turned out to be a 10% margin. Clearly, this number should have
been at least 30% and probably closer to 50%. So, one reason for the cash
shortage was hardware sales profit was 200% lower than it should be. The bigger
issue however was that when the COO built expenses into his budget model that he
used to price the service projects, he did not include any of the company
overhead costs. He did not include building rent, employee benefits, phone,
inventory carrying costs, tools, office supplies, computers, etc. These costs
were equal to 33% of revenue. So, a couple of simple accounting/forecasting
errors set up this CEO and put her in the situation of actually loosing money on
every contract. The overall numbers came in to be that for every $1 she earned
in revenue she had to spend $1.33 to earn it. This company did not know how to
track cash flow.
The management team thought that there was
no way for them to increase prices to the correct level without loosing
customers. We agreed and suggested that they just increase prices by 5% on new
contracts over the next six months and see if there was any negative impact on
sales. There was not. We then suggested that they increase prices another 5%
and again there was no negative impact on sales. The CEO continued this slow
progression of price increases and steadily improved the cash position.
We also found that the COO was signing
contracts for work that would be completed over a three to six month period with
a single customer payment at the end of the project. This meant that the CEO
had to pay for all the hardware and employee overhead out of pocket for three to
six months before she got paid. This is a cash flow nightmare. So, we got the
COO to write all new contracts with up-front payments for materials and
milestone payments each month for labor completed each month. This turns out to
have been an industry practice that the COO had not implemented because he
thought it would hurt their sales success if he implemented it.
After working on these “piece-parts” we
worked with the CEO to put a cash flow management system in place. This
Weekly cash flow
reports from the accounting company that showed the last week and
year-to-date cash flow position.
forecasting process that “rolled-up” all the individual project forecasts
into a company wide forecast.
time to get invoices out to the customers from two weeks to three days.
accounts payable days from 20 to 45
These actions and some management training
moved this company to a break even position within six months and small profits
in one year’s time. The company did not loose any customers and was even able to
add customers with the new (higher) pricing. This is a real story and we hope
that it illustrates that it’s difficult for CEOs to know what they don’t know.
Some times your company’s cash flow is
impacted by the unknown. And, then sometimes the “unknown” is something you
could have or even should have known. In this talk with Paladin the company is
in the business of refilling and reselling laser printer and ink jet
This toner cartridge refurbishing business
has traditionally been a very lucrative business of picking up free expended
cartridges, buying some toner, cleaning and refilling the cartridges and then
selling them for half the price of the new cartridge. But, after a time the
original equipment manufacturers (OEM) started putting electronic chips in the
cartridges that burned out when the toner ran out. This meant that the
refilling companies now had to buy new chips and install them on the
reconditioned cartridges. Of course the OEMs charged a premium on these chips.
On top of this the OEMs started printing statements on the cartridges that said
that the printer warrantee was violated if a non-OEM cartridge was used in the
printer. So, now the cartridge refilling company had new cash flow requirements
to purchase the chips – eating into cash flow. And, they had to also spend
additional money on marketing activities to overcome the OEM statements that
using the refilled cartridge would invalidate the printer warrantee – more
negative cash flow.
The long term impact of this situation was
reduced cash flow, reduced margin and reduced profits. This situation was then
exacerbated by the introduction of low cost, high quality ink jet printers. For
two years, it was not economically feasible to commercially refill the ink
cartridges for resale. Then about a year ago a company introduced commercial,
high capacity ink cartridge refilling machines. Our cartridge refilling company
had to make major capital investments to purchase this new equipment. But, on
top of that there were training costs, new marketing programs, new inventory
costs, and more – which all negatively impacted cash flow.
The company could have seen these industry
changes coming and planned for them, but they did not. It took a couple of
years for them to dig out of the technology introduction hole they fell into.
We use this talk to make the point that
cash flow planning needs to include considerations beyond the typical things
discussed in the other talk with Paladin discussed above and the issues
discussed in the other article in this news letter. Cash management also
includes researching, planning and forecasting technology changes that may
impact your products. Then, you also need to update your sales, marketing and
financial plans to ensure you will not run into cash flow problems.
Brought to you by:
Bob De Contreras
RTBA | Cary | Greensboro | Raleigh | Research Triangle Park | North Caroliina
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