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Tips for effectively managing cash flow

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You can drive a sleek sports car with the latest technology under the hood, but it will sit dead on the side of the road if it runs out of fuel. In business, cash flow is the fuel that keeps your ideas in good operating condition and your people employed. As a result, managing cash flow is one of the top concerns that keeps business owners up at night.

Taking control of your expenses and spending can help you reduce cash flow uncertainty in your business. Here are some tips to help you overcome cash flow challenges.

1. Welcome steady, low-margin projects.

“Payroll is the cash flow challenge of every company with employees,” says Linda Henman, president of Henman Performance Group, a consulting firm specializing in business strategy and talent planning. “No matter how business is going, employees must be paid once a week or twice a month.”

Henman recently worked with a large construction company, which was making about a 6 percent profit margin on most projects. The company made a strategic decision that it needed cash flow to support the payroll of the 6 percent margin jobs, so it took on more 2 percent margin jobs, Herman says.

That lesson applies to businesses of any size: Don’t automatically turn your nose up at low-margin clients and projects. Although they may not turn a huge profit for your business, they can generate a revenue stream that will support your company during tough times. Steady, reliable work also keeps your workforce busy during slowdowns, allowing people to maintain and sharpen their skills.

With Henman’s client, the more modest projects also boosted morale.

“This company worked all over the country, so the workers were often on the road,” she says. “But the low-margin work was mostly local, so they could spend more of their time in town.”

Because low-margin clients aren’t as valuable to your bottom line as what Henman calls value-based work, plan their work in a way that best supports your cash flow model. For example, fill in the low-margin work as it suits your production schedule, focusing on periods of downtime for employees. For an accounting firm, that might mean taking on fewer smaller, low-margin jobs during tax season when you have more work than you can handle from your best clients. Also, you can request payment from low-margin clients in 30 days or less, as opposed to waiting 60 days or more for when high-margin clients might pay.

It’s also important to make sure you are pricing your core business correctly, says Henman. Otherwise, your 6 percent projects might not be as profitable as you think they are, and you won’t be in a financial position to take on low-margin work.

2. Build a flexible workforce.

Alternative workforce strategies such as outsourcing and hiring contract workers are another way to smooth out cash flow, says Michael Fritsch, president and COO of the project management and consulting firm Confoe.

“Avoid the ‘hire and fire’ cycle, which is very expensive in real terms,” he says. “Instead, put together a flexible work and outsourced workforce model by strategically adding a contingent component that goes on top of your core employment levels as needed. Amazon is a great example. They hire a lot of retirees and staff up with people who just work during key seasons.”

Courier companies and retailers work in much the same way, hiring temporary labor during times when they’re most confident that revenue growth will exceed the added expense.

Of course, businesses using contingent workers must put effective systems and processes in place to find, train and onboard new hires and quickly bring them up to speed, something that isn’t realistic for every company or industry.

“You have to consider how complicated the work is,” Fritsch says. “How long does it take someone to ramp up? If it takes three months to learn the job and temp workers are only there for four months, a contingent workforce isn’t a good idea for your business.”

3. Stretch payment terms.

Shorten the terms of your receivables and lengthen the terms of your payables to improve cash flow, Fritsch says.

Your goal, as always, is to hold on to your money as long as you can. Extending your payables schedule with vendors isn’t ideal because doing so can bruise your reputation in the marketplace and cause friction with suppliers. But you may need to consider this option if cash flow is tight.

This strategy works best if your company has a strong market position in relation to your vendors. They won’t like getting paid later, but they’ll probably put up with it — at least for a period of time. The downside is that after awhile, they may adjust their pricing to account for your slow payments, Fritsch says.

Another important component of this strategy is to invoice your clients immediately. Some business owners try to set aside a certain time of the week or month to do all of their invoicing, but that prolongs the start of your 30-, 60- or 90-day period in which you receive payment.

4. Stabilize revenue through subscription pricing.

Unpredictability is the enemy of steady cash flow. To avoid cash flow peaks and valleys, which make hiring and projecting revenue difficult, encourage subscription pricing.

“A one-year contract with monthly payments offers a nice predictable flow of cash, with fewer receivables,” Fritsch says.

It won’t work for every company, but more companies than you might expect can take advantage of a subscription pricing model. Gym memberships, janitorial services and online music subscriptions are common examples, but accounting firms and law firms can implement this model in the form of a monthly retainer. The more project-based clients you can convert to subscription payments, the more predictable your cash flow will be.

5. Build a war chest.

Is cash flow not a problem for your company? Good for you – and may your good fortune continue. But there’s no guarantee that it will. Economic conditions and industry stability can change in the blink of an eye.

In an Entrepreneur Magazine article titled “How Much Cash Do You Need for Your Business’s Safety Net?” the author writes about Reece Sewing Machine Co. Never heard of it? That’s the point. The company was awash with cash after World War II, when it looked like sewing machine orders would never slow down. But when business flat-lined a few years later, the business went bankrupt, the victim of overconfident spending and too much overhead.

Abundant liquidity isn’t an excuse for abundant spending. Plan for the future during lucrative times by building your war chest, a fund you can use to reinvest money into your business as you need to.

As a rule, avoid parking excess cash in savings accounts at local banks. Online banks offer much higher interest rates than brick-and-mortar competitors due to their lower overhead.

6. Find a way to accept work, even when you’re too busy.

You want to keep your clients happy as possible, but that difficult to do if you turn down their business when they need you most.

Many consultants, freelancers and independent service providers know the angst of refusing work during busy times and waiting for the phone to ring when business is slow. Henman advises businesses to find creative ways to say yes when an opportunity is available, even if doing so seems like a stretch.

“Do as much as you can, and then get temp help or hire part-timers or use other consultants,” says Henman.

Henman has been on both sides of the consultant relationship, sometimes taking on overflow work from peers and other times contracting it out. The important thing is to remain the primary contact for your clients so you are the one building the relationship.

“Even if you break even on the job, you’ve developed a relationship that could prove valuable in the future,” she says.

When partnering with another company or consultant, only work with those you trust to do great work and be professional, and who you are confident won’t poach your clients when the job is finished.

7. Master inventory management.

If your company stockpiles materials for production or operations, better inventory management could help you minimize risk and increase the predictability of cash flow.

One strategy is to have a consignment inventory, which involves contracting with a supplier to keep your warehouses and facilities stocked only on an as-needed basis.

“You don’t buy inventory all at once, but you’ll pay your supplier to manage the inventory level for you,” Fritsch says. “The advantage is being able to avoid big cost expenditures at the beginning of a manufacturing cycle.”

It’s also a way of making sure warehoused materials don’t become obsolete.

Just-in-time (JIT) inventory management is a similar strategy, which involves maintaining barebones inventory and ordering only when needed. Inventory never sits in storage and is used almost immediately to turn a profit.

Managing cash flow is a constant challenge for most companies and one that must be confronted aggressively. “Cash flow needs to be a strategy rather than a tactical decision,” Henman says. “Stay proactive, not reactive.”

Bonus tips

Entrepreneur Chris Chocola says one of the earliest lessons he learned in business was that “balance sheet and income statements are fiction, cash flow is reality.” To position your business for long-term success, here are a few more strategies for effectively controlling cash flow.

Always have financing in place. Do all you can to get a bank loan or line of credit established before your company needs it. No matter how successful your business is, there will come a time when you face a cash crunch. You want to seek funding when your company is in a stable position.

Extrapolate your cash needs. Prepare cash flow projections so you’ll know as far in advance as possible when problems are likely to occur. You should also have an understanding of when major cash outlays are expected.

Triage your payments. If the time comes when you can’t afford to pay everyone, you’ll have to make some hard decisions. First to be paid are lenders (so they’ll be open to lending to you again) and the vendors that are most critical to your operation. Consider approaching all of your vendors to ask about extending your payment schedule. Bills from one-time relationships can slip to 90 days or later if necessary. But don’t even think of putting off the IRS. The resulting fees and penalties can slowly choke a business.

Use the FOGS framework. This good advice comes from the Wall Street Journal. FOGS is an acronym that helps businesses determine the validity of major expenditures. Ask yourself these four questions: What’s the financial impact of the purchase? How will it affect my operations? Will it further my goals? Will it align with my strategy? If the purchase doesn’t line up with one or more of those questions, you’ve saved your business from a major expenditure and contributed to better cash flow.