Financial Quicksand - What's that sinking feeling?
Feb 23, 2010
Have you ever watched an old movie in which a person is running through a swamp in an effort to escape from “the bad guys” and stumbles into a bog where he becomes stuck? Despite his determination, the more he struggles, the more firmly he is stuck. He survives only with help from outside the pit he is in - either a vine, just within reach or someone throwing him a rope. The last thing he would need is more sand and water. Yet that seems to be the solution that many businesses seek when they have trouble servicing their debt - they seek more debt.
It has been my unfortunate experience to encounter a growing number of businesses that are struggling in this difficult economy. The primary reason in virtually all instances was the difficulty or inability to meet their debt obligations. The demands of paying the normal day-to-day operating expenses, coupled with the difficulty of paying their long term loans becomes a downward cycle. Perhaps you have heard the expression, “you can’t save your way to wealth?” While I believe that is true, even more true is you can’t borrow your way to wealth.
So if a company is strapped for cash and more debt is not the path to take, what should a business owner do? Because an owner must generally pay for the materials or goods before they receive the cash from their customers, how does one cover the gap that exists? I believe there are a few strategies that might be employed.
• Stretch Payments: If timing of the cash flow is the issue, a business might negotiate with vendors to increase the terms for payment say from 30 days to 45 or even 60 days. I realize that some customers (particularly the big corporations) unilaterally inform their vendors that they now will make payment using 45 or 60 days. I personally feel that this is a violation of the vendor’s trust and is a dishonest business practice. If you can get vendors to agree, this would stretch out the cash flow demand and bring it more inline with the timing of receipts from customers.
• Eliminate non-essentials: Obviously, the company should eliminate ALL non-essential expenses. Sometimes companies incur expenses for good reasons, whereas they should focus on expense that result in GREAT outcomes. Postpone or eliminate as many expenses as possible to free up cash.
• Obtain an advance on Accounts Receivable: Companies might be able to obtain an advance on pending Accounts Receivable through a process known as factoring. Banks or factoring companies provide loans against a portion of Accounts Payable - generally those which are less than 45, maybe 60 days old. Similar treatment may be available for Raw Material and Finished Goods inventories. There are restrictions on the age of the receivables and the type of inventories and the percent for each varies. The mistake many companies make is that they don’t pay back this advance, thus making it a long term debt (not a good idea) which can further exacerbate an already difficult cash flow situation.
• Pursue payments from customers: Don’t forget to aggressively pursue timely payment from your customers. If your terms are Net 30, try reducing the terms to Net 15, ideally for all customers, but certainly for new ones. Also, if you are a contract manufacturer, obtain upfront payment for the material portion of the contract. Ship portions of the total order and bill as soon as the partial shipment is picked up by the carrier.
• Consolidate debt: If there are multiple long term loans already in place, look at consolidation of the loans in order to reduce the total monthly payment, thus freeing up cash. Regardless of the number of loans, look into obtaining a more favorable interest rate and payment terms. But, DON’T take on more loans.
These are just a few ideas to help businesses improve their cash flow without taking on more debt. Granted, factoring results in a loan agreement, but I view it as an advance on sales that have been already made and a way to speed up the collection process. Implementing ideas such as this can help companies improve the availability of cash. And as we all know, Cash is King.