Cash,
Also King
"We are profitable, but it’s always a struggle to pay bills and sometimes even to meet payroll. That’s why I would like to write a business plan to raise additional cash," explained the owner of a mid-sized production support facility. "I read your column about business plans, ‘When Showing Up Is Not Enough,’ and decided to call you."
"A business plan to raise cash could help expand the company, add another location, or purchase the next generation of equipment," I replied, "but this doesn’t seem to be your objective. Let me see your latest monthly financial statements."
"Monthly? We prepare them quarterly," he said.
"First mistake," I said. "To effectively manage the operation, you need monthly financial reports that should be available less than a week after the end of the month. Let me see this week’s receivable aging instead, and the accounts payable aging as well."
"Our accountant prepares those when the quarterly financial reports are done," replied the owner, now getting a bit defensive.
"Second mistake," I replied. "Receivable and payable aging reports should be done at least weekly. With today’s accounting software, this information can be available at any time. You wouldn’t read last month’s newspaper and expect to be up to date on the news. Why should financial reports that are weeks or months old be any different?"
Companies in this situation are not unusual. According to a recent study published in the Journal of Accountancy (yes, I admit to being a subscriber) one in five small business owners rate accounting and bookkeeping as their number-one management weakness. And the report said that this is the number-one way that owners could improve their skills and their company’s prospects.
I looked at my client’s latest financial statements. Because they were able to accurately bid and complete the work on time and on budget, the company was profitable. And their spending habits were not excessive.
But a review of their balance sheet proved that Accounts Receivable and Accounts Payable were out of proportion. Furthermore, the aging reports showed that a significant percentage of the amounts they owed and that were owed to them were overdue.
Delving a bit further, I asked their accounting department to prepare a report that stratified Accounts Payable data. I was looking for how long it took an invoice to be entered into their accounting system after it was issued by the vendor.
The results were amazing! Seventy percent of their invoices were input more than 21 days after being issued. And the reports also showed that more than 90% of the total dollars paid were paid on invoices input over a month after the invoice date. This meant that the accounting department often had to pay invoices the day they arrived in the department, frequently at the insistence of complaining vendors. This obviously allowed insufficient time to plan cash flow.
Making payments was always an emergency situation, often requiring a manual check instead of one included in the weekly computer run. Manual checks take significantly more time than computer checks and drain important resources from more productive work.
A walk around the production department revealed part of the problem. Many of the in-house producers and department heads had stacks of incoming invoices sitting on their desks. Because they were too busy to do paperwork, or simply had a sheer dislike of it, invoices were not being approved and sent to accounting until a vendor called to complain.
Accounts Receivable, the amounts owed from customers, were also way out of proportion. Although the company spelled out its bids carefully in its proposals, it failed to include adequate payment terms. A small upfront fee may have been required to start work, but the rest of the contract price was not due until the end of the project. This practice had been acceptable when the company did mostly quick projects, but as the length of the projects increased, it became a significant cash flow problem.
Furthermore, there was little communication between production and accounting. Sometimes weeks would pass after a project was delivered to the customer before accounting was told to send the final invoice. Then it frequently took several days before the billing clerk could get the invoice out. Often it was not discovered that an invoice should be sent to a customer until the customer requested one in order close the books on the project. What an embarrassment! No wonder there was always a cash crunch, even in this profitable company.
Fixing both problems would not be hard. It would only require that the company change its mindset about accounting matters. The staff had to have as their motto: Cash is King. Their paychecks depended on it.
It would also require a change in the way they handled relationships with customers and suppliers alike. Many employees would need to assist in new program and, in some cases, change the way they did their jobs.
We designed a comprehensive but relatively simple program.
For the Accounts Receivable:
- All proposals included benchmark dates on which payments were due.
- Accounting maintained a log of estimated payment dates for each project and prepared invoices, subject to producer approval, several days before the benchmark date.
- Payments over a set dollar figure were to be made via wire transfer.
- Aging reports were produced weekly and reviewed at the regular staff meeting.
- Responsibility for monitoring the account (and for prompt follow up) was given to each producer.
- For producers, this was no longer a part of the job "when they got around to it," but an item that appeared on their performance appraisal. It became every bit as important as getting the job done on time and on budget.
For the Accounts Payable:
- Purchasing prepared a P.O. for each item, approved in advance by each producer. A copy was sent to accounting.
- Vendors were instructed to send all invoices directly to accounting.
- Receiving documentation was sent to accounting promptly.
- If the total on the invoice was comparable to the P.O., the invoice was entered into the system with no further involvement of the producer.
- Payment terms were reviewed with many vendors. Most agreed that they would be willing to get payments 30 to 45 days after invoice date if they could be confident that the company had its act together.
In a relatively short time, the plan worked. Cash crunches were fewer and further apart. The company could now plan its cash flow and was even able to invest short-term excess cash.
We often say that content is king, and may have come to believe that it is the only king. But without effective cash flow to feed the content king, all is for naught. If cash flow is a problem for your company, consider implementing a similar program. The results could be surprisingly positive, and you may be seen as a king (or queen) for suggesting it.
