A Few Modest Proposals to Improve Cash Flow

There are few companies that don’t need to focus on cash flow these days.  With an improving but still uncertain economy, building cash reserves and lowering debt remain the dominant practices to protect against another downturn.  While there are any number of steps a middle-market company can take, from better credit policies and practices to better inventory management, to improve its cash flow and position, here are 7 simple ideas that I’ve seen many clients overlook.

  1. Engage in cross-educating your customers at the outset about payment practices.  It’s all well and good that a supplier communicates its payment terms (e.g., net 30 days) as part of its invoicing or even its initial establishment of a new account.  However, few bother to inquire what the customer’s standard payment practices are.  Especially when dealing with a large customer, find out if that customer intends to throw its weight around, as in “If you want to do business with us, you’ll accept the net 75 day terms that we have with all vendors”.  It’s not true that all vendors accept those terms.  Do you think the customer’s landlord gets paid 75 days after the 1st of the month, or its insurance company 75 days after the premium due date?  Your company can also establish expectations of prompt payment on your terms, starting with negotiating payment terms with the large customer as part of winning the business.  After all, on-time and complete delivery of your high-quality services or goods is why they selected your company in the first place, and that requires prompt payment.  Knowing what the customer’s standard practices are before you start doing business provides you the opportunity to negotiate for your terms rather than accepting the customer’s.
  2. Obtain all required contact information at the outset.  Often an invoice gets sent to one party at the customer, but information on payment status comes from other departments, such as Accounts Payable.  Make it part of your account set-up process to obtain all the information you’ll need to follow-up on invoice status and payment.  People are creatures of habit; if you submit a form as part of the account set-up, they’ll typically fill it out and return it.  Ask for the information before you need it, and you’ll be glad to have it when it’s required.
  3. Establish a credit limit for each customer and stick to it.  Determine how much money you’re willing to risk or how old you’re willing to let invoices get (e.g., 60 days) and set a credit limit.  Inform your customer at the outset that you expect prompt payment and if an invoice exceeds the age limit or if invoices in aggregate exceed the credit limit, your company will cease providing services or goods until the situation is rectified.  Yes, I know – you believe the customer will simply shift to another supplier.  Most often that won’t happen, but if it does, consider whether you want a customer with increasing risk, and/or amount, of a bad debt.  There is no revenue, much less profit, if you’re selling to a customer that doesn’t pay.  By the way, you can always make an exception to strict enforcement of the credit limit if you need to.
  4. Seek to be paid via electronic means, such as ACH (Automated Clearing House) or EFT (Electronic Funds Transfer).  Invoices are generally approved for payment by the appropriate party providing a signature or other authorization.  Whereas payments by check often require an additional signature or other manual step – after the check is cut – those that are paid by ACH or EFT do not.  The electronic payment will very likely be more timely, as automated systems recognize the stated payment due date and initiate the electronic payment.  A check that has to be signed and/or mailed is more likely to be held by a customer.
  5. Provide incentives rather than disincentives for invoice payment.  It’s the rare company that charges a late payment fee, such as 1.5% per month, and actually collects it.  Instead, offer your customers a prompt payment discount, such as 1% 10, net 30.  The treasury departments of large companies assign high priority to earning prompt payment discounts and will generally not take the discount inappropriately (that is, pay late and still claim the discount).  Coupled with electronic payment, such incentives will significantly accelerate payment.  While the discount is not inexpensive compared to the costs of borrowing money, often middle-market and smaller companies do not have the luxury of sufficient lines of credit as an alternative.  Where possible, build the cost of the discount into your pricing.
  6. Follow-up with the customer early and often.  Most companies only start to call or email their customers about payment after the payment due date has gone by without receipt of payment.  Contact the invoice recipient 7 to 10 days after the invoice is sent (whether by email or other electronic means or by the less-preferred snail mail).  Using a “customer service” tone, use the opportunity to confirm the invoice was received and identify if there are any issues with it.  If you identify an issue at 10 days rather than 30 or more, you’ve just accelerated correction of the problem, as well as payment, by 20 or more days.  Another email or call about 5 days prior to the invoice due date to ascertain that the invoice is approved and in process to be paid will also help assure timely payment.
  7. Act like a bigger company when you set payment terms with your customers.  If your invoice terms are net 30 days but it takes 45 days to collect on average, negotiate with your suppliers for payment terms of 45 to 60 days.  You’d be surprised at the success you may have.  I have one client whose average Accounts Receivable Days Sales Outstanding are 50 to 55 days, which is unusually efficient given the industry sector and geographical market that they serve.  Their vendors are aware of the slow-paying nature of the customer base but are unaware of this company’s particular success in collections.  The client has negotiated payment terms of 60 to 90 days with its vendors, resulting in no need for a line of credit and very low interest expense.

These modest changes in your company’s approach to cash flow management can make a huge difference in the cash flow of your business. .

About Ken Drossman

Ken Drossman is a Managing Director at Oak & Apple Partners, LLC. Ken has spent more than 35 years demonstrating practical financial acumen by leading, advising and guiding privately-owned, small and middle-market companies through financial and operating challenges. He has in-depth experience in all phases of financial, strategic and operating management from hands on cash flow budgeting through acquisition financing, from divestiture of business units to reorganizing and leading newly formed companies. Prior to co-founding Oak & Apple Partners, Ken has been the principal at Lakeview Business Consulting, LLC, which assists entrepreneurial business owners and their companies in achieving their business vision. Ken earned both his undergraduate and graduate degrees from The Wharton School of the University of Pennsylvania. Before founding Lakeview Business Consulting in 2006, he served for 18 years as CEO, COO and/or CFO at several privately-owned companies, in industries including financial services for hospitals; digital document storage and outsourced back-office services for professional service firms; design and distribution of personal business accessories through big-box retailers; capital goods manufacturing for national and regional retail chains; and information services for beverage alcohol manufacturing and marketing companies. Previously, Ken was a Partner at Grant Thornton, LLP, where he provided management consulting services to such companies as AT&T, Baxter Laboratories and GTE-Sylvania, as well as many middle-market companies.
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