Control Cash And Credit: Cash Flow, Manage Receivables & Inventory

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Cash Flow

What levels of debt can your business safely support? Can you control the amount, timing, and availability of credit? That is, can you ensure the timely inflow of cash from new debt?

Assume that you have done all you can realistically do to control your cash flow, but you still face occasional periods of cash shortfalls. To tide you over these periods, you have to borrow from an outside source, e.g., a commercial bank or credit-card company line of credit. How do you go about preparing a financing proposal? Begin by focusing on receivables and inventory. Chances are they are your largest current assets against which you might borrow.

Ideally, receivables and inventory turn into cash as soon as you wish. However, unless you manage them carefully, cash flow and carrying costs become a problem. To manage your working capital properly, you must know:

The age of your receivables and inventory,
The turn of your receivables and inventory, and
The concentration of your receivables (how many customers comprise the majority of your receivables, what amount of receivables they represent, what products the receivables cover) and inventory by product lines.

You must also know what your credit and collection policies are doing to your working capital. All too often small-business owners mistake sales for profits. They extend more and more credit, pursue lax collection policies, and end up financing their customers to increase sales. Most businesses cannot afford to provide interest-free loans to customers just because they expect it. Slow-paying customers must be subjected to profitability analysis, which takes in their carrying costs. Sales increases should translate into profits on the bottom line, but it's difficult to increase profits when you're carrying customers who habitually stretch their payments.

Receivables management. To control receivables, begin by examining their age. Break receivables out weekly to spot the slow-pay accounts as soon as possible. Then you can try to collect before the accounts cost you your profits. Aging receivables is simple: Separate invoices into Current, 30 days, 60 days, 90 days, and more than 90 days. Then calculate your collection period: Divide annual credit sales by 365 to find the average daily credit sale. Next, divide your current outstanding receivables total by the average daily credit sale. This yields your collection period. Here's a good rule of thumb for a quick test of your receivables management: If your collection period is more than one third greater than your credit terms (for example, 40 days if your terms are net 30), you have a looming problem.

Five Steps to Managing Receivables

Age your receivables.
Calculate your collection period and apply the "40-day/30-day" rule of thumb to see if you have a problem.
Identify slow-paying customers.
Pursue delinquent accounts vigorously.
Identify fast-pay accounts and try to increase their number.

Managing your inventory. Inventory management, like receivables management, is often overlooked as a source of operating profits. Careful attention to how you manage these two areas can often free up cash and improve operating profits without resorting to bank borrowing. If you are managing both of these areas well, congratulate yourself-you are in a distinct minority.

Carrying costs of inventory can run as high as 30% of average inventory, a substantial drain on working capital. Consider the costs of storage, spoilage, pilferage, inventory loans, and insurance. They add up fast.

Determining the right level of inventory to carry is difficult. On the one hand you want to avoid unnecessary expenses, while on the other you want to avoid as many stock-outs as possible. Trying to manage inventory on a day-to-day basis invites trouble; accordingly, most businesses use some kind of inventory policy. The three most important factors in creating an inventory policy are inventory turnover (how many times per year, and how that compares with other businesses in the same line), reorder time (planning on a 10-day reorder time is vastly different from a 210-day reorder), and who your suppliers are.

Inventory control is a balancing act. If your inventory gets too high, you run out of cash. If it is too low, chances are either you're buying in uneconomical quantities (a danger sign to bankers), you're too undercapitalized to ever become profitable (another danger sign), or you're bleeding the business. Bankers are increasingly interested in the quality of inventory as well as the more standard indicators of good management (liquidity, profitability, and track record). If you have a cogent inventory policy and follow it, you will upgrade both inventory quality and profitability.

Establish a contingency plan. A contingency plan is a plan you hope never to use: It outlines what you would do if all of your optimistic plans went wrong. It doesn't have to be lengthy. In some cases, it can be as short as a single page and still be more than adequate, although for most businesses such a plan will be somewhat longer. A contingency plan should provide answers to these questions:

What suppliers would give you extended terms or carry you in case of a crunch? Why would they carry you? How long, and how much?
What new investment could you make? Would you refinance personal assets to provide a cash cushion for your business? Could you? What other assets could you bring to support a cash crunch?
What assets does your business have to either sell or turn to cash some other way if necessary (perhaps a sale/leaseback, for example)?
How will you keep your banker and major trade creditors on your side?
Have you examined all possible sources of additional working capital in your business? Where might you have some leverage?
What customers would be willing to prepay or speed up orders if it would help you?

The purpose of a contingency plan is to make sure before a crisis is at hand that you won't panic. As evidence of thoughtful business management, it's hard to beat and is being sought by more and more creditors.

Tighten and maintain cash controls. Cash flow control begins with the cash flow budget. If you don't have a cash flow budget, you will have cash flow problems. You also need a sales budget or its equivalent to keep the sales level where it should be. Small sales lags can add up to big problems if not spotted early-ranging from a sluggish salesperson to a less than honest clerk.

Your cash flow budget is a tool for keeping over head costs down. You have a degree of control over costs that you don't have over sales; while you can almost always cut costs, you can't generate sales (especially cash sales) whenever you need to. If you could, you'd never have a cash flow problem.

Every budget has some fat in it. Tightening controls means always asking whether this or that purchase or expenditure will have a positive effect on your business. If there is no clear answer, examine the expenditure closely. This effort must be consistent to work. All the controls in the book mean nothing unless they're applied-whether the control is a separation of purchasing from paying, making sure that bills and reorders go out when they should, or even keeping a physical count of the inventory.

Collections Follow-Up Form
Name:
Telephone:
Spoke To:
Title:
Subject:
Date:
Time:
Initials:
	No Answer	Not Available
	Requested Info	Requested Proof Of Delivery
	Order Never Received	Payment Previously Sent
	Will Send Check	Merchandise Returned
	Duplicate Billing	Payment Being Held
Comments:
Returned Call:
Follow-up:

Credit and collection. The cost of extending credit is one of those hidden costs that cats up working capital. Very few smaller businesses have explicit credit policies. If they did, they could dramatically increase both profits and the quality of their current assets.

Investigate accepting credit cards and encouraging customers to use them. They cost little in return for the headaches they save you. Consider the cost, in direct comparison to bad debt losses, and in time, effort, and attention that slow-pay accounts cost you. The added costs of capital tied up in receivables, for example, is frequently greater than any fee charged by the financial institution supporting the transaction.

Use a follow-up form each time you call a lagging account. The completed slip will provide back-up information and should be filed for reference on further calls. Remember to ask for specific payments on specific dates. If payment is not received, call back and ask again.

Three Credit Policy Steps

Divide your customer list into three groups: Prime, Good, Other. Prime customers always pay within term; Good usually do; Others seldom, if ever, do.
Look for similarities within the groups: What kinds of customers are Prime or Good? How do they differ from Other?
Look for ways to upgrade as many customers as possible to Prime and Good. Remember: You don't have a sale until you're paid.

Financial Management Definitions:

Accounts payable: Liabilities resulting from purchases of goods or services on an open-account basis.
Accounts receivable: Amounts owed by customers as a result of delivering goods or services and extending credit in the ordinary course of business.
Balance sheet: A financial statement that shows a company's assets and liabilities.
Budget: A forecast of revenues and expenditures for a specific period of business activity.
Cash flow: Usually refers to net cash provided by operating activities; there is also cash flow from financing and investing.
Cash flow statement: A report on cash receipts and cash payments for a particular period.
General ledger: A record containing the group of accounts that supports the amounts shown in the financial statements.
Gross profit: The difference between sales revenue and cost of goods sold.
Income statement: A report of all revenues and expenses pertaining to a specific period.
Inventory turnover: The number of times during an accounting period that a business sells the value of its inventory. Turnover is calculated by dividing the cost of goods sold by the average inventory during the period. (Average inventory is figured by adding beginning and ending inventory, then dividing by two.)
Line of credit (LOC): An agreement by which a financial institution (usually a bank) holds funds available for a business's use. A secured LOC is ordinarily renewed annually; an unsecured line may have to be paid down once a year.

Cash is KING!

Always remember cash flow is the life blood of your business.
You must measure the flow in and out of your business.
You must carefully MANAGE this cash flow or you will not be in business very long.
Always remember Cash is KING!

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