The current recession has created numerous financial problems for businesses, especially the smaller ones. With people cutting back on spending, many businesses are struggling to keep their doors open and remain profitable, as evidenced by the numerous stores closing across the country. Payment cycles have also changed and been shortened for many businesses, making it tougher for them to collect on receivables.
“Customers are having their own financial issues that are causing them to pay slower, which is ultimately causing a slower receipt of cash,” says Bill Lambert, vice president and credit officer at Fifth Third Bank. “On the flip side, vendors are requiring faster payments in some cases, which has snuck up on a lot of companies. These changes in the payment cycle have been a big cash flow issue for a lot of companies.”
Smart Business spoke with Lambert about how to improve your cash flow in this down economy and how creating a cash flow budget can make you flexible for the future.
How can you improve your cash flow?
Take a look at a 13-week cash budget going forward. Simple is better with cash flow. Take a look on a week-by-week basis, roughly a month to a quarter out in the future, and put down what you expect to receive and what checks you actually expect to write. It sounds outrageously simple, but a lot of companies don’t do that. If you look at your historical business from last month or last year, that’s a decent indicator of your ability to be profitable. But when you break out the cash in and cash out, it can be enlightening.
Be more aware of the sources and uses of cash in your balance sheet and working capital accounts. There are three primary issues to be concerned with here, the first being appropriately managing the accounts receivable, which includes preparing bills faster for customers. When economic times were better, some companies could maybe go a week or two at a time without preparing and sending bills because the cash flow wasn’t quite as important. Today, it is more important to prepare and collect the cash faster.
The second component is inventory. Having a lot of cash tied up in your inventory can be a constraint on the company. You need to limit the amount of time that your cash is tied up in inventory. The third piece is with accounts payable and how slowly or quickly you pay your vendors. If you have the ability to wait a little bit longer to pay your vendors without hurting your credit standing with them, that can ultimately be a source of cash, as well.
How does cash flow analysis come into play here?
From a traditional standpoint, companies will look at their net income, add back noncash items like depreciation and consider that their cash flow. Look at more of the cash flow budget, because it adds a little more reality to the scenario. Analyzing your cash flow like that can get to the heart of the issues a lot faster sometimes.
How can you make your budget flexible for any unexpected receipts of expenditures?
The key is to keep it on a rolling basis. Looking at it weekly, you can better account for the things that you didn’t plan on. If you can look out over four to six weeks, to the extent that some vendor credit terms allow you to you delay the payment of an item for a week in order to accomplish paying something else, you can see your short-term future much better. Constantly updating that allows you to be flexible.
What problems can you run into if you don’t improve your cash flow?
Ultimately, it’s not a lack of profitability that causes problems but a lack of liquidity. People talk about the five Cs of credit, but the only important C is cash. That liquidity is either cash the company has or the company’s ability to turn their assets into cash quickly. Without that liquidity, the company has a hard time making its payroll, paying its bills, etc.
What are the benefits of improving your cash flow?
Financial flexibility. When you are as efficient as you can be, that gives you the ability to reduce leverage and not carry as big of a debt load. It allows you to be in a better position if you have a period of time when revenue drops or general economics are tough. That financial flexibility buys you time during those points.
BILL LAMBERT is vice president and credit officer at Fifth Third Bank. Reach him at (513) 965-5163 or [email protected].
