December 1, 2009

By Wendy Kram

Cash is king and many small businesses are in danger of running out in today’s slumping economy. Business owners are struggling to find cash flow strategies that will help them survive the recession. Kamakura Corporation reported on December 1, 2009 that the Kamakura index of troubled public companies at risk of defaulting jumped from 10.68% in October to 11.43% in November. The index reached a peak of 24.3% in March of 2009[1]. The index has come down significantly since March yet, the recent increase suggests companies both large and small are still struggling to stay financially viable.

The stakes are high and decisions critical, so what can you do to keep your business afloat? Let’s explore some of the reasons cash flow is an issue in today’s economy and learn practical strategies from three financial experts who work with small businesses on a daily basis.

Common Problems

Common cash flow problems exist for many small businesses as monitored by Pam Krank, President of The Credit Department Inc. of West St. Paul Minnesota- a credit risk and receivables management firm. First, revenue is down across the board, as much as 50% in some industries. Incoming cash flow has been tremendously hurt by this reduction in sales. Secondly, businesses operating on anything other than cash terms are experiencing customers lengthening payables with slow payments. Small businesses that haven’t had accounts receivable issues in the past are not used to exerting effort to collect payments and lack the skills and systems to effectively get customers to pay.

Additionally, customer default is an increasing problem that is putting more small businesses at risk for bad customer debt. Lastly, banks are less willing to support working capital needs by refusing line of credit increases. Banks are carefully analyzing risk and forcing many businesses to convert lines of credit to term debt. The result is a cash crunch for businesses that are required to meet a significant monthly payment.

Inventory management is another vital cash flow issue. Many businesses are making the mistake of building up inventory during slow times, but don’t the have the sales to support it, observes Stacy Shaw, CPA and Manager of Boyum and Barenscheer PLLP of Minneapolis Minnesota- certified public accountants and financial advisors. The business is at risk of running out of cash because the majority of their cash is tied up in their warehouse.

Manage Risk

Managing accounts receivables is one of the key strategies for keeping the cash flowing. What can you do to speed up customer payments? More than you might think. According to Krank, the most important step is to negotiate favorable terms up front in the sales process. Don’t be afraid to ask for money up front in the form of a deposit or a retainer. Enforce your terms by immediately calling customers when invoices are past due. What should you do if a customer is experiencing cash flow problems? One option is to create formal payment notes with interest and agree to do all future business on a cash basis.

Avoiding bad customer debt is a must for a business that wants to remain financially healthy. Krank suggests businesses need to know a lot more about their customers before extending credit to them. Customers should be required to fill out a formal credit application which specifies payment terms and conditions. It is critical that you understand risk and the probability of bad debt happening before you do the deal. Krank recommends reviewing public records for all customers such as liens, judgments, foreclosures, and bankruptcy, which are all signs of a negative risk. Sizeable credit risks warrant additional research such as reports from Experian^SM, Dun & Bradstreet and bank references. Bank references provide critical information on cash flow; as a vendor your account should be a small percentage of the customer’s monthly cash flow. Be wary of customers who refuse to provide financial information- take it as a sign they are experiencing financial difficulty.

"Understanding your financial position is a key component in having a successful business and managing cash flow"- Stacy Shaw

Understand Cash Needs

Cash flow projections are an important tool in understanding the cash flow needs of the business. Stacy Shaw recommends the following steps to improve cash flow management: 1) Create cash flow projections with best case, base case and worst case scenarios, 2) Focus on understanding short-term cash needs, 3) Ensure accurate estimates of income taxes, 4) Keep sufficient cash reserves in the business, 5) Understand line of credit terms and conditions including compliance ratios, and 6) Establish a line of credit when you don’t need it. “Understanding your financial position is a key component in having a successful business and managing cash flow,” Shaw said. Determine the company’s breakeven point to better understand how long can you stay in business and to proactively identify financing needs.

Conserve Cash

Conserving cash is a key strategy for weathering the recession recommended by Arleen Sullivan, President of Anchor Bank St. Paul N.A, Eagan Office. Sullivan cautions many businesses are operating with a cost structure that can not be supported by soft revenues. “Business owners need to act quickly and dramatically to adjust their cost structure to match revenue. They need to be willing to make difficult decisions such as reducing personnel, to ensure the business remains viable,” Sullivan said. Review expenses with a fine tooth comb; everything has to be on the table. Ask vendors for discounts or request an extension of terms. Lay off employees or freeze wages, if necessary, based on projections. Work with your financial advisors to help you remove emotion from the process to be more objective when slashing expenses.

She also suggests leaders need to consider reconfiguring the business to match the current needs of the market. Evaluating business results to shift resources to profitable areas, discontinuing unsuccessful product lines or services or entering new markets can all be effective coping strategies. Be more aggressive in capturing billable time and invoicing promptly if you are a services firm. Capturing and billing end customers for pass through expenses is another strategy for increasing cash flow.

"Business owners need to act quickly and dramatically to adjust their cost structure to match revenue. They need to be willing to make difficult decisions such as reducing personnel, to ensure the business remains viable"- Arleen Sullivan

Explore Financing Options

Timely and accurate financial reporting from your accounting system is important for you and the bank. This is an unforgiving climate for slow financial information. “Banks will act quickly when they see stale financial reporting and will be forced to assume the situation is not good,” Sullivan said.

What can you do if you are in danger of running out of cash? Banks can work with a temporary glitch in profitability and cash flow but, when sustained losses are not improving and the turn around timeline is not clear, the business is not likely to remain a good fit for the commercial banking world. The main focus of commercial bank lending is cash flow. The primary source of repayment needs to be there because banks generally don’t lend on underlying collateral.

Look objectively at every source of liquidity that you have beyond the bank and create access to those as much as possible. Evaluate private resources such as a home line of credit, trimming personal spending, and retirement savings; assess risk to determine which assets you want to leverage.

"Don't sell your way out of this economy- cash flow your way out." - Pam Krank

Financing options exist outside of commercial banks, but they may be more expensive or require a more creative approach. Accounts Receivables factoring is the selling of accounts receivables or invoices in order to secure immediate working capital for a fee. It is sometimes possible to arrange for financing through a key customer. Review your life insurance policy; some life insurance policies allow for loans against the policy. Contact local development and government agencies to determine if you qualify for financing through business incentive programs. Also, working with your accounting professional to connect with equity investors is another strategy for finding alternative funding sources.

Prevention is often said to be the best medicine and it holds true for cash flow as well. Strong financial controls, informed management of risk, decisive leadership and open communication with financial advisors can help you to reduce the risk of cash flow problems. Never lose sight of your cash flow. Review a statement of cash flow report monthly, if not weekly, to understand your financial position. “Don’t sell your way out of this economy- cash flow your way out,” Krank said.

“Keep the Cash Flowing with These Tips”

1.  Act quickly and aggressively to conserve cash by reducing expenses
2.  Shift resources to profitable areas and discontinue unsuccessful products or services
3.  Negotiate favorable payment terms with customers before the sale
4.  Ask for money upfront in the form of a retainer or deposit
5.  Research the credit history and financial health of customers before the sale
6.  Don’t stock pile inventory without sales
7.  Provide timely and accurate financial reports to your bank
8.  Understand the terms and conditions of your line of credit
9.  Create cash flow projections for best case, base case and worst case scenarios
10.  Keep sufficient cash reserves in the business
    

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