Want More Cash Flow? Check your Accounts Payable Cycle

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Understanding the levers that drive your company’s cash flow can be the difference between staying in the game or closing up shop. A business can have positive net income, but still come up short of the cash it needs to keep the doors open.

One of those metrics that can cause a lack of cash is your accounts payable collection cycle. It’s one of the four key pillars that drive cash flow.

Accounts Payable Cycle

Some company’s vendors offer the ability to buy their products or services and pay them later. Offering this credit is like getting a short-term interest free loan from the vendor. As part of the deal, your vendor will want to get paid back based on the payment terms they offered. Understanding how long it takes for you to pay vendors is critical to your cash flow.

How do you measure it? Below is a formula that calculates your accounts payable days to pay cycle. Like the accounts receivable collection cycle, this calculation is based on a “snapshot in time” and you will want to monitor it on a regular basis such as monthly.

Formula:

Total expenses / 365 days= daily expenses
Accounts Payable / daily expenses= days to pay cycle

Example:
$900,000 / 365 days= $2,465 daily expenses
$50,000 / $2,465= 20 days to pay cycle

In the above example it takes approximately 20 days for the company to pay its expenses. Some expenses are probably paid upon receipt and other expenses may offer up to 30 days or more to pay. If this metric could be stretched from 20 days to 30 days the company would retain approximately $24,000 in its bank account. This could give it more time to collect accounts receivable from its customers and allow it the cushion it needs to pay bills on time and feel comfortable meeting its obligations.

How could it stretch the days without upsetting its vendors? A couple of strategies:

  • Ask vendors for longer payment terms
  • Use a company credit card to “time” the payment to a vendor. Most credit card providers give you up to 30 days after your statement ending date to pay the outstanding balance. Depending on the timing of your payment, this can add up to 30 to 45 days more time to pay.

Know your accounts payable payment cycle. Monitor it on a regular basis and look at strategies to extend it while working with your vendors to pay within the agreed-upon time. The right accounts payable payment cycle could be the difference between positive or negative cash flow!

Want More Cash Flow? Check your Accounts Receivable Cycle

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I sometimes hear from business owners that they are making a profit, but they don’t seem to have positive cash flow at the end of the year. What happened?

Your business may generate a positive net income, but if you aren’t monitoring other key cash flow drivers, then you can find yourself strapped for cash to meet the obligations of the business.

One of those drivers that can cause a lack of cash is your Accounts Receivable (A/R) collection cycle. It’s one of the four pillars that drive cash flow (along with Accounts Payable, EBITDA, and Inventory Days-on-Hand)

Your Accounts Receivable Cycle

Many businesses offer customers the ability to “Buy Now, Pay Later” for their purchases. In other words, they are providing customers a short-term interest free loan to pay for the product or service! If your customer doesn’t pay on time or takes longer than you expect, it can create a cash flow problem in your business.

Monitoring how long it takes for you to collect your accounts receivable is important. The quicker you can collect it, the quicker you get the cash you need to pay your bills and reinvest for your company’s growth.

But how do you measure it? Below is a formula to determine your collection cycle. Keep in mind your cycle will shift weekly, monthly, quarterly, etc… The calculation is merely a “snapshot in time,” but it’s important to know.

Formula:
Annual sales / 365 days= daily sales
Accounts receivable balance / daily sales= days to collect accounts receivable

Example:
$1,000,000 / 365 days= $2,740 daily sales
Accounts receivable $80,000 / $2,740= 29 days

In the above example, it takes on average about 30 days to collect the amounts owed by the company’s customers. If this metric increases from 29 days to 39 days, then the extra 10 days has left the company with $27,400 less cash in their bank account than if they had collected it in 30 days. This is where the business owner could see a positive net profit in the profit and loss statement, but also see that their cash balance has decreased by $27,400.

Know your accounts receivable collection cycle. Calculate it on a regular basis, such as monthly. Identify customers who are consistently not paying on time and determine a strategy to encourage them to pay within the terms you have offered. It can be the difference between positive or negative cash flow!

For more resources to help you measure this important metric, check out our Numbers Coach tools and templates.

Preserving Cash In Uncertain Times

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I’ve been watching the news and talking with colleagues and clients and wanted to share some strategies with you for preserving cash that may come in handy.

1. Research refinance options for any high interest loans and ask for some or all of the closing costs to be waived.
2. The Small Business Administration has created a program to fast track low interest loans under its Economic Injury Disaster Loan, visit: www.sba.gov/disaster
3. Reach out to your lenders about deferring payments, or reducing to interest only payments, on debt.
4. Ask your landlord if you can pay rent at the end of the month (in arrears) for the next 90 days.
5. Ask your landlord about reducing or deferring Common Area Maintenance (CAM) charges for the next 90 days.
6. Call clients to see who can pay faster/earlier.
7. Call vendors to see if you can get extended terms or defer some portion of invoices to a later date. 8. Ask vendors to take payment on a company credit card.  Ask the vendor to charge the amount just after the credit card statement drop date.  This can defer a payment from 15-45 days if timed correctly.
9. Reach out to your credit card company to ask for reduced or zero interest for the next 90-120 days. 10. Bill customers as quickly as possible.
11. Consider whether you have any customers who might pay now for future delivery of services.
12. Defer your personal tax return filing and payment to July 15th.  The IRS issued a recent ruling that is allowing a delayed 2019 tax filing until this date.  However, if you are owed a refund, file your return now to get the funds.

Congress is in the process of an enacting special legislation called the “CARES Act” which is in the Senate at this time.

If you think of other ideas, I’d love to hear them!  My belief is that we will come out of this stronger and definitely together.  Scientists around the world will find the path through for our collective well-being.

Stay well!  And if you have any questions, concerns or just want someone to talk through your ideas, don’t hesitate to reach out.    Mike

Preserving Cash in Uncertain Times

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I’ve been watching the news and talking with colleagues and clients and wanted to share some strategies with you for preserving cash in the short term that may come in handy in the long term. Here are 12 strategies I recommend:

  1. Research refinance options for any high interest loans and ask for some or all of the closing costs to be waived.
  2. The Small Business Administration has created a program to fast track low interest loans under its Economic Injury Disaster Loan, visit: www.sba.gov/disaster
  3. Reach out to your lenders about deferring payments, or reducing to interest only payments, on debt.
  4. Ask your landlord if you can pay rent at the end of the month (in arrears) for the next 90 days.
  5. Ask your landlord about reducing or deferring Common Area Maintenance (CAM) charges for the next 90 days.
  6. Call clients to see who can pay faster/earlier.
  7. Call vendors to see if you can get extended terms or defer some portion of invoices to a later date.
  8. Ask vendors to take payment on a company credit card. Ask the vendor to charge the amount just after the credit card statement drop date. This can defer a payment from 15-45 days if timed correctly.
  9. Reach out to your credit card company to ask for reduced or zero interest for the next 90-120 days.
  10. Bill customers as quickly as possible.
  11. Consider whether you have any customers who might pay now for future delivery of services.
  12. Defer your personal tax return filing and payment to July 15th. The IRS issued a recent ruling that is allowing a delayed 2019 tax filing until this date. However, if you are owed a refund, file your return now to get the funds.

Congress is in the process of an enacting special legislation to provide relief for businesses and individuals called the “CARES Act” which is in the Senate at this time. Click on this link for a summary of some items in the Act.

If you think of other ideas, I’d love to hear them! My belief is that we will come out of this stronger and definitely together. Scientists around the world will find the path through for our collective well-being.

Stay well! And if you have any questions, concerns or just want someone to talk through your ideas, don’t hesitate to reach out.

Cash Flow Forecasting Keeps You in the Black

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by Anne Moore Odell

Like blood beating through the heart, cash flows in and out of a business. Cash flow is not profit. Rather it is the money coming into the business through sales and other revenues and it is the cash leaving the business, for example, as paid invoices and payroll. Cash flow, or cash on hand, is simply cash in minus cash out.

Cash flow forecasting, then, is the process of looking forward to what you expect your cash flow to look like over a set period of time. The period can be for a month, 12 weeks, or even as long as a year. It is an extremely useful tool for businesses as it can provide insights to improve profitability.  If management has a well-constructed cash flow forecast for the year ahead, it is in a strong position to plan, execute and control improvement measures.

“Forecasting cash flow helps businesses be realistic rather than idealistic”,  says Jack Koester, a  Counselor affiliated with SCORE(r) Lake/Sumter Chapter 414 in Florida. “Cash flow forecasts are tedious and require substantial due diligence. But survival is the main early benefit.  It always has been, but it is much clearer today.” SCORE(r) provides free online and face-to-face business counseling, mentoring, and training.

Creating a Forecast

A cash flow forecast is a written document that makes note of all the cash that you expect to receive and all the cash that you expect to pay out over a given period.  Plan for when you will receive payment on invoices so that you can efficiently time your payments to vendors.  To be useful the forecast needs to be updated frequently, honestly, and in the current economic times, conservatively.

There are many programs available to help with cash flow forecasting, but one of the best is one that your business probably already uses daily: Excel. “An Excel spreadsheet allows you to create a forecast that matches the size of your organization, the inflows and outflows,” says Mike Iverson, CEO of Trillium Financial.  These types of models can be effective ways to measure near term cash flows such as a rolling thirteen week plan.

For businesses interested in a cash flow software program, one provider is PlanWare.  Says Brian Flanagan, Director, PlanWare.org, “The simplest solution is to develop a cash flow forecasting plan using a spreadsheet. This can be a do it yourself worksheet or based on a template located on the internet.

Another option is a full software program that you can purchase such as PlanWare’s Cashflow Plan.  It offers a range of forecasting planners some of which are  integrated into your budget planning which includes a balance sheet, profit and loss statement, and a cash flow statement.  The benefit of the full software program is a change in sales automatically adjusts the cash inflows from receivables and values for cash and receivables in the balance sheet based on your assumptions.  These plans can be effective for longer range planning such as over a 12 month or longer period.

Cash Flow Forecasting in a Recession

“Many more companies are generating cash flow forecasts today. Cash is always an issue, even in good times,“ says Iverson. “I have more clients that forecast 12 weeks out, especially now. Cash flow forecasting for the next 12 months can be more difficult.”

Iverson adds, “With ever larger, more seemingly secure companies declaring bankruptcy, asking for extended terms, and making slow payments, cash flow  is definitely trickier than it has been in years past. Making it even more important to do.”

“If we feel clients are being too optimistic, we strongly suggest they project a separate set of cash flow projections based on a WORST CASE scenario. Sobering!” says Koestar.

“More of your Fortune 500 or Fortune 2000 companies are using cash flow forecasting. Typically, they don’t have a huge need to forecast cash short term,” Iverson adds. “But companies are making sure that they are going to have cash and capital, regardless of their size, forecasting more frequently and in shorter time frames.“

“In buoyant times, businesses were reasonably sure that cash would automatically follow on from profitable trading,” says Flanagan of Planware. “This allowed firms to gear up and pursue higher sales without worrying unduly about getting paid or securing additional credit for working capital purposes.“

Flanagan continues, “The downturn has changed all this and the key issue has become the maintenance of cash flow. This is, in many senses, more important than profitability as more businesses fail because they run out of cash rather than generate losses. Cash flow forecasting has become critical in two areas. First, short-term planning for receivables, payables and inventory to ensure that working capital (cash) is managed effectively. Secondly, medium-term forecasting, e.g. for 12 months ahead, so that firms can anticipate cash flow problems.”

Forecasting cash flow is always difficult. The recession has exacerbated this because it has disrupted established trends and patterns.   However, when forecasting during a recession, Flanagan has two suggestions: First, concentrate on higher-level forecasts as these can be just as accurate or possibly more accurate than very detailed projections. Second, make forecasts based on alternative scenarios, for example, “most likely case” and “most probable worst case”.  Aim to hit the former but take actions that presume the latter will occur.

Cash Reserves Help Your Business Weather the Storm

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by Michael Iverson

“Save it for a rainy day” is an old saying that still makes sense today. In good times, it’s smart to put aside something for the lean times that are sure to follow.

For a business owner, saving for a rainy day means building cash reserves. Liquidity is the lifeblood of any business, and a lack of liquidity is the cause of most business failures. Squirreling away cash during times of prosperity may, one day, save your business.

A cash reserve provides a business owner with the financial flexibility to continue operations during difficult times. In a sluggish economy, for example, a business may receive less cash from operations than anticipated. Customers who lose jobs are unable to pay their accounts on time. As a result, the business owner finds there’s simply not enough cash coming in to meet business expenses.

The owner can’t very well tell employees and vendors that they won’t be paid until customers pay their accounts, or he risks driving them away. A wise business owner wants to keep his employees and vendors happy, so he pays them on time. He usually does so by tapping into the cash reserve he established during good times.

Cash Reserve vs. Line of Credit

Business owners that have the foresight to build generous cash reserves are sometimes reluctant to tap those reserves. When difficult financial times arrive, a business owner shouldn’t feel any guilt about putting those reserves to use. The funds were saved with a specific purpose in mind—one day the business might not be able to generate adequate cash from operations.

When that day arrives, the question to ask is whether it’s best to dip into the cash reserve fund or make use of an available credit line. Usually, the conservative stance that led the owner to build cash reserves prevents him from taking on debt. But, there are circumstances when using the credit line makes sense. We recommend that you pose the question to your financial advisor.

When it’s considered best to use the cash reserve fund, the money will be put to good use. It will pay the salaries of your employees that have helped you achieve so much over the years. Hopefully, they will continue to be productive employees for years to come. This is a time for looking ahead. Make it a celebration of good business planning and loyal employees.

Opportunity Knocks

Cash reserves may also provide unexpected opportunities. Suppose a competitor of yours is highly leveraged. He has grown his business using borrowed money. He didn’t anticipate an economic downturn and never gave much thought to putting aside cash for a rainy day. What happens if his customers can’t pay their bills in a timely manner? He will have a tough time making payments on his business loans. If the problem is serious enough, he might be forced to liquidate the business. His customers could easily become new customers of yours. His employees might become your employees.

Not sure how to reserve some cash every month?  Contact Michael for advice on how to modify your current business financial model to weather future storms.

Cash Flow Statement: The Best Starting Point for Business Planning

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by Michael Iverson

Check out this sample Cash flow statement for Acme Company

It’s my observation that most business owners review their financial statements in the following order:

  1. Income Statement
  2. Balance Sheet
  3. Statement of Cash Flow

Why is that so? Perhaps the most likely reason is that business owners borrow money. The lenders from whom they borrow focus on Income Statements and Balance Sheets, so those reports naturally become important to business owners.

However, when it comes to business planning and improving business results, I encourage clients to first look at the Statement of Cash Flow. As I’ve stated in previous articles, cash flow is often the most challenging metric for a small business to master. Balancing growth against the availability of cash is one of the most critical issues for a small business. Getting it wrong can put the business in peril.

Components of the Report

Unlike the Income Statement and the Balance Sheet, the Statement of Cash Flow is not based on accrual accounting. Rather, the report shows how a company generates cash and how its cash is spent. The concept of accrual accounting is matching the expense to the period when the obligation occurs or revenue to the period when it is earned. The cash flow statement is only concerned when a bill is paid or revenue is received.

The report has three component parts:  Cash Flow from Operating Activities; Cash Flow from Investing Activities; and Cash Flow from Financing Activities.

  1. Cash Flow from Operating Activities includes cash receipts from customers less amounts paid to suppliers and employees. The company in the example is generating healthy cash flow from its core operations.
  2. Cash Flow from Investing Activities shows a net cash outflow due to equipment purchases, which could be expected for a growing company.
  3. Cash Flow from Financing Activities is a large net cash inflow due to capital contributions and proceeds from a sizeable loan.

Check out this example for the ACME Company:  Cash flow statement

Improving Business Results
In the space of one year, the ACME Company in the example cash flow statement markedly improved its cash position. The beginning cash balance of $22,000 increased to $176,000 by year’s end.

During the same time span, the company invested in new equipment and replacement equipment. The new equipment might have been necessary for a new product line. The replacement equipment ensures against any unplanned disruption of existing production capacity. It appears that the company has prepared for continued growth over the next few years. With healthy cash flow from its core operations, the company is poised for growth opportunities.
Of course, there are risks involved with any new initiative or product introduction. Perhaps the new product line won’t do well which could put pressure on repaying the loan. To help mitigate those risks, setting aside cash as a reserve affords some breathing room if new initiatives don’t work out.

What is your Statement of Cash Flow telling you about your business? Have you achieved a cash position that provides a reasonable cushion for unforeseen events? If an incredible growth opportunity presented itself today, would you be able to act decisively?

If you would like to discuss how your business is positioned, contact us.  We’re glad to help you create and interpret your Cash Flow Statement.

How Weak Cash Flow Affects Your Business

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by Michael Iverson

In a recent article, I discussed a company that had greatly improved its cash position in a year’s time. To complete the discussion, it’s important to consider reasons why a company’s cash position might deteriorate from one year end to the next

Take a look at the following Statement of Cash Flow:

Statement of Cash Flow for ABC Company for the year ended December 31, 2013

Cash Flow from Operating Activities   

Cash receipts from customers                     568,000

Cash paid to suppliers and employees       (622,200)

Cash generated from operations                  (54,200)

Interest received                                                    500

Interest paid                                                       (1,200)

Taxes paid                                                         (2,900)

Net Cash Flow from Operating Activities         (57,800)

Cash Flow from Investing Activities

Equipment additions                                           (10,500)

Replaced equipment                                           (24,200)

Proceeds from sale of equipment                           1,900

>Net Cash Flow from Investing Activities             (32,800)

Cash Flow from Financing Activities

Proceeds from capital contributions                   12,100

Repayment of loan                                             (19,300)

Net Cash Flow from Financing Activities             ( 7,200)

Net Increase/Decrease in Cash                 (97,800)

Cash at January 1, 2012                               122,600               

Cash at December 31, 2012                           24,800

In the statement above, the Cash Flow from Operating Activities is a negative number. As you can see, cash receipts from product sales are exceeded by the cash paid to company employees and suppliers. That’s not a good sign.

The objective of any business is to generate cash sufficient to cover all expenses and pay owners/investors a reasonable return. In this instance, the product sales for the business didn’t quite meet the costs associated with manufacturing and selling the product. Unfortunately, there were no returns on investment for the owners and investors.

Rapid Depletion of Cash

Looking at the cash balances at the beginning and ending of the year ($122,600 to start the year vs. $24,800 at year’s end), the healthy cash balance at the start of the year was seriously depleted by year’s end. The situation is serious enough to threaten the viability of the business.

The problem is the company’s negative Cash Flow from Operating Activities. By reviewing the year’s budget, we could determine the extent to which actual Sales for the year fell short of budgeted Sales. If actual Sales fell short of budgeted Sales, we would further examine the reason(s) why.

The other possibility is that the Sales was fine, but collections for products sold fell far short of expectations. In other words, product sold and delivered was not paid within the payment terms provided to customers.

Cash Flow from Investing Activities shows that equipment purchases totaled $34,700, increasing the negative cash flow. Since equipment purchases could include both replacement equipment and new additions for product expansion, these investments can put a further strain on the business.

Capital Contributions Required

The owners contributed $12,100 in capital during the year, however, loan repayments used $19,300 of cash. Are there more loan repayments due in 2014 and beyond? If so, then the owners will likely be required to contribute in 2014, assuming the cash flow from operating activities continues to be negative.

Borrowing money from a bank will be difficult given the company’s poor cash flow.

Keep a close eye on your Cash Flow from Operating Activities and understand the drivers of this number. This knowledge can be the difference between staying in business and going out of business.

If you would like to discuss how your business is positioned, contact us.  We’re glad to help you create and interpret your Cash Flow Statement.