If you're running a small business, especially one that is growing, then chances are you are broke all the time.
The cash float problem that occurs during business growth is a mathematical rational reality that is easy to understand, but still punches you in the gut. Knowledge of a problem in life or in business does not obviate the need to solve it, nor does it prevent the hurt that can be caused. You have a growing profitable company — you’re a winner — except that you’re out of cash all the time and barely escaping bankruptcy. How is this possible?
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If you work in consulting, you probably can't get away with having your customers pay in advance and waiting to pay your employees and consultants until you’re good and ready.
What is Cash Float?
Simply put, if you are in a position (as most of us are) where you must pay to create something before you sell it, and your customer pays you 45 days later or so, then you have at least 45 days (but usually more) where you have spent money that you aren’t getting back. This is called “cash float” or simply “float.” If your business is in a steady state (i.e., not growing much), your float will be equal to two or three months of income. For example, if your company makes $120,000 each year ($10,000 per month), the float is probably $20,000 to $30,000. If your revenue is $1.2 million, your float is $200,000 or more. If your revenue is $12 million, your float is $2 million or more.
When success comes your way and sales increase from $240,000 to $1.2 million per year, your float also increases from $40,000-plus to $200,000-plus. Unfortunately, that money has to come from somewhere. Part of it will hopefully come from profit, but unless your profits are obscenely high, they are probably insufficient to enable the kind of growth you are experiencing.
People will tell you that this is a "nice problem to have," but if it causes you to go bankrupt, then there's nothing nice about it at all. It's nice that you're growing, of course (unless you're growing unprofitably), but you still have a thirst for cash that is worth lessening. if possible.
There are 4 ways to deal with this cash float problem.
1. Find Investors or Lenders
Taking out a loan, including factoring loans, and selling stock, options, or warrants to investors of various flavors are great ways of generating cash. Selling stock to investors is beyond the scope of this article, but getting a loan is generally well understood. In a small business you will probably have to sign personally for it as a secondary payer. This means that if the business tanks (as many do), the bank will come after you for the money. If you don’t want to sign as a secondary payer on a bank loan, then you can look into factoring.
Factoring, or selling your company’s accounts receivable at a discount, is a popular way for small companies to borrow money. My company, Journyx, used this method in the early days. I hated it. We would invoice a customer, send the invoice to the bank, and receive 80% of the money once they had verified the invoice with the customer. The bank, however, was reluctant to call customers about invoices below a certain amount, and since we had many invoices that were small, factoring was not very effective for us. There was quite a bit of overhead involved for a relatively small amount of benefit. One unanticipated benefit, however, was that customers would sometimes tell the lender important things that they had not told us. We were able to learn more about our customers that way.
2. Bill Early, Bill Often, Bill Accurately
Another way to reduce float is to decrease the average number of days it takes you to collect your accounts receivable (a.k.a. A/R days-to-collect).
Making Your A/R days-to-collect a Negative Number – The Magic of Michael.
Michael Dell famously achieved a negative A/R days-to-collect by outsourcing just about everything (for an added level or recursion, he even outsources the task of figuring out how to outsource people), getting money from customers before he built their computers, and paying his vendors notoriously slowly — typically after 90 days or more.
Using these ideas, Dell actually created a negative float, enabling him to grow much faster than his competitors at the time. He couldn't have done it without an online store, a population that was willing to buy direct on the web with credit cards, which gave him the cash instantaneously, and vendors who were willing to be paid very slowly (essentially lending him money interest-free). This negative cash float business engine that Michael created was an unstoppable powerhouse of growth for Dell for many years, propelling the company to the #1 position in profitability, growth, and most of the other metrics that influence the financial performance of any business. For a decade or so, Dell’s stock soared, but eventually competitors caught on and copied the model.
If you work in consulting, you probably can't get away with having your customers pay in advance and waiting to pay your employees and consultants until you’re good and ready. If you do figure out how to pull this rabbit out of your hat, then please drop me a line, ‘cause I want in! You can, however, automate employee time collection, import the data into QuickBooks (or your favorite accounting system) and, in the process, get those several hundred thousand dollars worth of paper timesheets off of your floor. This will reduce your float from about three months to two. If your average monthly sales are $200,000, then congratulations, you just found $200,000 to grow your business with.
One of our customers, an environmental consulting firm, came to me a few years ago with a problem. They had bought our software, so I called them up as I often do and asked, "Why did you buy our software?" Becky, the CEO, said, "I'm hoping you can help me with this huge problem I have."
"What's the problem?"
"We're growing really fast, from 40 to 300 people in just a few months. I mean, business is just incredible!"
"Okay. That doesn't sound like a problem to me. That sounds like a really good thing. I wish my business was doing that. What's the problem?"
"Well, I can't find the time to get the bills sent out to our customers. I'm looking at a giant stack of paper timesheets on the floor in the corner of my office that represents like $500,000 or something. Help!"
So we helped.
By putting an automated timesheet and travel expense management system in place, Becky was able to drastically increase the speed of billing, lowering her float and providing cash for the business. Accuracy also skyrocketed, leading to fewer situations where customers were rejecting inaccurate invoices, which pushes A/R days-to-collect down further. Additionally, since everything was automated, it became possible to invoice in smaller increments more frequently, and since small bills tend to get paid more quickly, this improved the cash situation even further.
All that cash — from the humble and often maligned timesheet. Go figure.
Getting bills out faster is worth a lot of money. If you can reduce your float permanently, it's worth loads.
Just take care when you implement such a system. If you don’t remain diligent, you will find yourself having to put that “found money” right back into the system. In other words, if your A/R days-to-collect number starts to increase, it can cause significant financial heartburn. For example, if your business is selling $300,000 worth of products or services each month and you lower your A/R days-to-collect by one day, you just found $1,000. But if it goes the other way, you need to go borrow $1,000.
3. Bribe Your Customers To Pay Faster
Now you have your invoices going out quickly, accurately and in small packages. You’re a genius. But how can we reduce your float even further?
Another way to encourage people to pay more quickly is with standard terms. Putting the phrase "1% 10 net 30" on your invoices is a standard way to tell your customers' accounts payable clerks that you will give them a 1% discount if they pay in 10 days, but that they must pay in 30 days. Some companies have standard policies that essentially force them to take all discounts. Long ago when I worked for a consulting firm that sold services to IBM, we labeled all of our invoices this way, and since IBM represented 90% of our business, our average A/R days-to-collect was – you guessed it – 10 days. 10 days is a ludicrously low collection time. When I bragged about that to other business people they called me a liar, and I giggled all the way to the bank.
“1% 10 net 30” are common terms, as are “1% 15 net 45.” If you’re really worried about a customer never paying, try “5% 15 net 30.” 5% is a huge discount, and if he doesn’t take it, then either he’s broke or he didn’t like your service. Either way, you know something that you didn’t know before.
There is something magical about using these kinds of terms on an invoice. People talk a lot; they make promises. But who really cares what they’re saying if, when the rubber meets the road, they don’t pay their bills on time, or at all? Talk is cheap. When money changes hands, real data is communicated. Companies have invented systems to make sure that money doesn’t leak out. A monetary transaction means more than a promise, more than a letter of intent, more than a purchase order, and more than a sales order. Money is real. And if you offer someone a 5% discount to pay quickly and they don’t take you up on that offer, that means something, and you need to figure out what that something is.
4. Blackmail Your Customers To Pay Faster
Sound like a bad idea? Wait — hear me out.
There is no rule that says you have to do this next thing, or that you have to do it consistently across all customers.
But another trick is to include penalty terms in your contracts and on your invoice. You don't necessarily have to enforce them — particularly on your favorite customers — and it will still have some effect. Many companies sort their vendor payment schedules by penalty amounts. Want to be at the top of the list?
If you have a particular customer that is always paying you slowly, indicate on the invoice that there will be a 1% surcharge on all invoices paid over 30 days late. Or 2%. Or 5%. Whatever. You don’t actually ever have to press the issue. But maybe the threat of a surcharge is all those customers need to pry open their tight wallets!
Happy Invoicing!
About the Author
Curt Finch is the CEO of Journyx, a provider of web-based software that tracks time and project accounting solutions to guide customers to per-person, per-project profitability. Journyx, which is based in Austin, TX, has thousands of customers worldwide and is the first and only company to establish Per Person/Per Project Profitability (P5), a proprietary process that enables customers to gather and analyze information to discover profit opportunities. In 1997, Curt created the world’s first Internet-based timesheet application — the foundation for the current Journyx product offering. Curt is an avid speaker and author, holds seven patents, and recently published All Your Money Won’t Another Minute Buy: Valuing Time as a Business Resource.
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