By Michael Beller
Like many small business owners, NFIB member Richard Sinclair struggled mightily in 2009 and 2010. Sinclair is the president of Applied Process Equipment Inc., a water and wastewater treatment company in Scottsdale, Ariz. The Great Recession and subsequent sluggish recovery dried up not only Sinclair’s business, but also spooked his local bank: When the bank announced it was eliminating all lines of credit that were less than $5 million, Sinclair was suddenly without a lifeline he had counted on for 13 years, and one he needed more urgently than ever.
“You want a real wake-up call?” Sinclair recalls. “That brought us home.”
Sinclair says there were instances during those two years when he believed his company could go under. Business remained stagnant and he could not count on his old bank for financing. Now, nearly three years after his credit line vanished, Sinclair has no doubt about what saved his business: proper cash flow.
“If we hadn’t had that degree of knowing to the last dollar exactly where we were, there’s a very good possibility we may not have survived,” he says.
Cash flow management is a common challenge for small businesses. Many owners do not have a background or proper training in finance, and banks have tightened the screws on lending to many small businesses since the recession. According to a Citibank survey, one-quarter of small businesses dealt with a cash-flow shortage last year due to late payments. In addition, a 2012 NFIB study found 1 in 5 small businesses were unable to secure any financing in 2011, while 1 in 4 were only able to get a portion of what they wanted. NFIB’s Chief Economist Bill Dunkelberg says the biggest U.S. banks are lending the smallest portion of their deposits in five years, as cash floods in from savers and a slow economy dampens demand from borrowers.
With payments coming in and bills going out, cash flow management can be an intricate dance. Getting a handle on it, however, can insulate your business during uncertain times, and open doors that would otherwise be closed. Since Sinclair’s water treatment business emerged from survival mode in 2011, he has been able to take advantage of opportunities that would not have been possible without a strict handle on cash flow.
“Last year, we were able to take advantage of two opportunities that brought several thousand dollars to our bottom line,” Sinclair says of two partnerships he was able to make with other local businesses. “Our cash flow was absolutely essential [to that].”
Managing the Basics: 4 Steps
The key to achieving cash flow stability and predictability is making sure your receivables and payables are visible on your balance sheet, or in a separate spreadsheet, says Anish Rajparia, president of ADP Small Business Services, a global payroll, human resource management and employee benefits outsourcing firm. To accomplish this, he recommends a four-pronged approach aimed at establishing a regular schedule for your business’ collections and expenses.
First, know in advance what your payroll cost will be every pay period. Since payroll is the largest expense for most businesses, this fairly simple projection will bring a big chunk of certainty to your cash flow. Rajparia encourages owners to have timesheet and attendance systems in place to ensure predictability of payroll.
Second, Rajparia says the norm for businesses is to make insurance payments on a quarterly or annual basis. That leads to huge, lump-sum payments, which can sabotage a business’ cash flow. Instead, Rajparia recommends making those payments every pay period.
“That makes it much more steady in terms of the flow,” Rajparia says. “Making benefits payments based on pay period helps business owners keep up with changes during an enrollment period. By making larger quarterly or semi-annual payments, owners miss out on predictability and need to have large reserves of cash on hand.”
Third, Rajparia says not enough business owners take advantage of retirement plans. Rather than determining how much of your business’ profits you can transfer for retirement at the end of the year—which is common for small business owners to do—saving regularly will help avoid taking a huge bite out of cash flow at year-end. This, of course, helps build more predictability.
Outgoing payments are just one part of the cash flow equation. Getting paid, especially on time, is a growing challenge for small businesses. A 2012 NFIB study found that 64 percent of small businesses have had invoices go unpaid for at least 60 days. Twenty percent of respondents also said incidents of late payments were increasing. (Read “Dealing With Delinquent Debtors” on pg. 39.)
Of course, those delinquencies have a domino effect. A study conducted by Experian, a global information-services company, and Moody’s Analytics, found that all businesses paid their bills an average of 7.6 days past due in the first quarter of 2012. For companies with fewer than 10 employees, bills were going unpaid for at least eight days.
“What’s surprising to us is that such a large portion of small businesses are affected by late payments,” Rajparia says—especially when there is a relatively simple change owners can make to help their situation. In running ADP’s small business services department, Rajparia has noticed an alarming number of small business owners still send paper invoices, an anachronism in today’s business climate.
The last part of his four-pronged strategy: Businesses should upgrade to an electronic cash flow management and invoicing system, through which they can save time and draw funds directly from a customer’s account or credit card.
“With some of the electronic tools, you can keep credit card numbers on file and get very regular payments. These sorts of systems are easy to manage and can help small businesses get [paid faster],” he says.
Check Your Expenses
Understanding the rhythm of your business’ financial cycle is an important component of controlling cash flow. For some small companies—restaurants and seasonal businesses, for example—cash flow can fluctuate wildly depending on the time of year, or even day of the week.
Take the automobile industry: New car buyers tend to wait until the end of the month, and later in the year, to make their purchases. That’s when car dealerships often have inventory they must unload, allowing consumers more room for negotiation on price.
NFIB member John Stubbs, who currently owns a real estate and investment firm, worked for Nissan for 25 years, eventually buying and running a dealership in Topeka, Kan. In a business that has to help finance purchases and then wait for repayment from a bank, cash flow can be especially tricky. Stubbs shares what an average weekend was like for him at Nissan.
“I’d sell probably about 10 cars and finance eight of them. You can come in Monday morning and have $250,000 in the bank, and by nightfall you’re overdrawn,” Stubbs says. “You have to have [cash on hand] to figure out how you’re going to write checks for all those cars.”
In Stubbs’ case, he was able to spend a few days each week with low funds in the bank because he knew when he’d have cash coming in next. That’s an important trait of any successful business owner, says Lawrence P. Burns, a certified public accountant with The Mironov Group, an accounting firm in Edison, N.J. In fact, Burns says the best way for a business owner to control cash flow is to compile a detailed history of inflows and outflows to help predict slow and boom times.
“Businesses don’t have as much control over money coming in, but they can control their expenses,” he says. Knowing the ins and outs of your expenses can help you make judicious cuts if cash flow becomes restricted. “Identify what outflows you have, and improve on the largest ones first.”
Owners should consistently take stock of expenses, and make sure they’re absolutely necessary. Josh Harris, a CPA and partner at NDH Group, a boutique tax and accounting firm in Chicago, says far too many business owners are not getting the “appropriate value” from their business expenditures: The cash is going out, but the return on investment isn’t necessarily there.
Harris says owners should ask themselves what they can do to reduce their costs in terms of both reccuring non-contractual expenditures and long-term contracts. “We find established businesses have line-item expenses they continue to repeat, without any real benefit to the company, and management isn’t always aware that these costs even exist.” Putting your business through this self-audit can help you identify expenses that you simply don’t need, to keep more cash on hand.
Even a savvy business owner like Stubbs can end up spending unnecessarily. In a business like his Nissan dealership, where the company has to incur expenses for making a sale and then wait a few days before getting full payment, every dollar counts. When Stubbs noticed he was spending too much on energy costs, he found simple ways to cut back.
“We turned the thermostat down at night and cut the lights off at midnight,” Stubbs says, even though he hints he would have preferred doing neither, “and we had the janitor come in every three days instead of every night.” The modest savings increased cash on hand, and helped manage the gap between making a sale and receiving payment.
Owners can apply the same formula to getting paid. While delinquent payments are no doubt frustrating, Burns says countless business owners are at fault for making it a challenge for customers to pay them. He recommends making invoices as simple and user-friendly as possible, echoing ADP’s Rajparia that sometimes business owners can do a better job of facilitating payment.
While providing standard information such as your billing address, date of service and line-items is a good start, some clients require further information, including a purchase order or tax ID. You should also invoice promptly, as soon as the order is filled or work is completed. For problem customers, Burns suggests asking for a post-dated check instead of turning them over to a collections agency, or severing ties. “At least [as an owner] I know on a specific day I can put money in without cutting a client off,” Burns says, which significantly decreases the chances the business gets paid.
Cash flow is critical at every stage of a business’ life. Without it, a business cannot purchase inventory, make a capital improvement or hire a new employee. Plus, an owner cannot attract financing or secure a line of credit if she doesn’t have the necessary cash on hand.
“It’s like the blood in the human body,” Rajparia says. “If you don’t have a handle on your cash flow—how much you have in the bank on a given day, what you’re expecting to get in contrast to what you’re going to pay out—it challenges your ability to run your business effectively.”