Cash Rules Part 2: Processes
In the first part of this series, we talked about the differences between short-term cash flow issues and long term profitability, and a big part of that was the role that cash rules play in the financial health of our business.
Today I’d like to continue on that line and talk about how you can take even more control of your cash, and get your customers to stop using you as a bank.
How the Customer Bank Works
I’ve worked with many clients that felt they were being abused by their customers. Here are some of the complaints:
1. Clients were slow to pay because they started the project without enough cash on hand.
2. Clients were slow to pay because they were waiting for the product to sell.
3. Clients intentionally start work knowing that they won’t be able to pay for it.
4. Clients continually tried to re-negotiate the terms in order to stretch their invoice due date.
In our business workshops, one of the most powerful strategies we teach is that of measuring cash flow efficiency, that is, how long does it take from start to finish, before you receive your cash. Simply put, the longer it takes to collect cash (in days), the more working capital you’ll need. We call this working capital days.
For example, you spend 10 days to start and finish a job, 20 days to invoice, and 60 days to get paid, then you’ll need to have at least 90 days of working capital on hand.
Obviously, this could present a serious problem for those business’ that are strapped for cash, which is why you need to focus not on cash flow problems, but on systems and procedures problems. Fix this, and the rest will follow.
Do you have a system in place for measuring the cost of work in progress (WIP) jobs? If not, it’s likely that you have scores of resources locked up in labor and material costs, but without the ability to measure that cost, you’re stuck guessing at cash flow needs. Again, this will lead you to yet more cash flow problems.
Instead of guessing, try this:
- Finish jobs on time and on scale
- Create a system for measuring WIP costs in dollars and in days
- Create a job management system
- Set appropriate completion targets for each job so that you know when to expect payment
Invoices are simple – you don’t get paid if you don’t send them. Therefore, it’s crucial that you get in the habit of invoicing promptly upon completion so that you can move on to the next client. If you find that you forget, or don’t have time to do it, then delegate that task to someone else. This is the single biggest area for immediate cash flow improvement.
Once you get in the habit of invoicing immediately after the job is complete, your clients and customers will get used to it, and hopefully, start paying accordingly.
Here are some tips to help you improve your invoicing process:
- Delegate invoicing ASAP
- Ensure invoices are prepared within 24 hours of job completion
- Set accountability procedures to ensure that invoices are prepared daily
- Create an official invoicing policy to ensure achievement of 24 hour turn around
- Know your clients/customers intimately to make sure your invoices are not interrupted by hours, dates, or procedures
Inventory, when managed improperly, can be very detrimental to healthy cash flow. If you have too much, then your money is tied up in overstock, but if you have too little, you might miss out on sales and revenue. The key is to monitor your inventory to the point where you know exactly how long it takes to move it into the customer’s hands.
This requires clear documentation and procedural data, but it’s important that you know your inventory like the back of your hand.
Treat every piece of stock as if it were an investment in a real share of stock. For example, if you have $10,000 invested in a particular stock item that might sell for $15,000 over the course of a year, is the $5,000 profit worth the cost of holding the stock? What if you could turn over five $1,000 pieces of stock for $2,000 each, in half the time? Which has the better return?
With the first set, you return 50% over a year’s time. With the second, 100% within six months. I think the answer is clear, the second set is the true winner here.
These are the nuances of inventory management, and why it’s so important to watch your stock come in and out the door.
Here are a few tips to help you regain control of your inventory:
- Measure stock days for each and every item in your inventory
- Calculate ROI per item
- Determine minimum stock for each item, and only order when you go under that number
- Develop plans and procedures for the moments when stock items reach obsolescence
Managing Debt Collection
Just like managing stock, the best way to manage debts is to measure how many days it takes to collect. Any invoice due is considered debt, and your goal is to have as little of this as possible. To better manage debt collection procedures, make sure that you have systems in place to ensure customers get used to paying on time, and that when they don’t, your company isn’t caught without a safety net.
Here’s how you can do that:
- Make sure you have written agreements in place before starting work
- Create a clear set of terms and conditions for your credit agreements
- Ensure that your debt collection policy is in writing and strictly enforced
- Identify both debt collection days and debt per customer
A perfect example of this is Dell CFO Tom Merideth, who spent 10 years reducing the working capital days at Dell from 63 days to less than 21. His goal was to have money in hand before they built a single computer, and it worked!
Fixing Cash Flow Once and for All
I’ve spent 25 years helping businesses with cash flow issues, and what we’ve touched on in this second part of this series is just a fraction of what SP Solutions can offer as a business advisory. In person, we could go over your business in very fine detail.
SP Solutions would be pleased to take you through a free business consultation to understand your current challenges and advise a plan ahead of how we can assist you to achieve future financial success. Click here to get your free business consultation.