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In theory, cash flow management is simple. Enough money must come into a business in time to pay bills and fund development of more products or services. But many business owners allow a chink to develop in their cash flow plan, and if the chink becomes a gulf it can be fatal. Rob Dalton offers a guide to creating and maintaining cash flow.

The most common issue that confronts owners of small and emerging businesses is managing cash, particularly during the growth phase of a business. While the ‘cash is king’ concept is widely acknowledged by business owners as the most important aspect of successfully managing a business, ‘revenue growth’ is almost always the major outcome on every business’s wish list.

Sales teams are typically deployed into the market to win sales and market share at all costs, however we rarely hear management teams enforcing the business’s key credit policies, procedures, strict payment terms, and profitability targets on new business. In every business, these aspects are just as important, if not more important than the new sale, because of the major impact on the business of having to finance growth.

So, what should business owners do to manage cash flow while also growing revenue?
There is no question that in order to improve the cash to cash cycle the whole business must be heading in the same direction and be very aware of the objectives. Many divorce the sales process from the debtor collection process, to the extent that often sales staff have no knowledge of the credit terms, credit application process, or even the debtor collection procedures. This is a scenario that often ends with a bad outcome for the business.

Here are a few ways to create a sustainable change to the culture of the business regarding cash collections:

* Management should clearly articulate the credit/collection policies, processes and procedures to the sales team. The credit policies and procedures should be top-of-mind to the sales team and discussed in sales meetings on a periodic basis. The policies and procedures should be succinctly documented and given to the sales team, so there are no excuses for not knowing what they are. They shouldn’t be tucked away in a filing cabinet. Laminate the policies, make a mouse pad for the sales team, or even put up credit term posters in the sales office so they remain top-of-mind.

* Management should set performance targets for debtor payments against terms. It is not enough to simply communicate to the sales team what the policies are. The old adage ‘what’s measured matters’ is most relevant when it comes to changing behaviours. The most effective cash collection measure is the time it takes individual accounts to pay–commonly known as ‘debtor days outstanding’. Anything outside trading terms or an acceptable range should be reported regularly to the sales team and the account manager. Such performance indicators are often included in the salary or commission structure, and so the sales representatives change behaviour because there is a financial impact or a consequence. While sales teams are often not responsible for chasing payments, if their pay or performance is linked to customer collections they are much more likely to give their client a gentle nudge around payment time.

* Clearly set expectations with new customers. It is typical in winning new customers that we do everything in our power to impress with lots of bells and whistles on what we can deliver, and in doing so we neglect to reinforce what our expectations are around payment terms. It is difficult to change behaviours once they have been established and all too often we hear the catch-cry ‘but we’ve always been a little late with payment in the past’. Management should have a process to ensure customers understand the credit or trading terms right from the start, with regular reinforcement from time to time. This preferably should be done in-person with a written confirmation so there is no misunderstanding. If someone can gain an advantage, human nature tells us they will take it, so don’t allow the enforcement of policies to be sloppy.

If all customers adhere to the business’s credit terms then as a business grows, providing payment terms for creditors are similar or better, financing growth should not be an issue for the business.

Cash Flow Management Tools

If there is a delay in timing difference between when average debts are collected and when creditors are paid, the business may require assistance to fund the gap. For this you might consider the use of debtor finance.

This has become much more popular in the last few years as the financial institution products in this area have become more refined and more affordable if managed correctly. Debtor finance is where a financial institution provides finance against current aged debts for a fee plus an interest.

The interest cost depends on how long each individual debt is outstanding, and so the recommendations listed above in creating a cash culture are just as relevant.

Debtor financing is used by businesses that typically have short-term commitments for their creditors and longer collection periods for their debtors, therefore creating a potential cash flow shortfall. An example of this is where a business imports product and pays by letter-of-credit prior to the shipping of the goods. In this example, payment will always proceed before receipt and therefore debtors financing may assist in ensuring the business can continue to fund purchases on a timely basis without running the risk of being caught short waiting for payments.

Debtor financing can be a very effective cash flow management tool–however, depending on the circumstances and the provider, it may exclude certain aged debts from the portfolio when providing finance due to history or slowness in payment. Again, effective collection procedures are critical, because debtor financing will be ineffective if debtors exceed credit terms.

Using a debt collection agency or outsource provider is also an option to be considered, depending on the circumstances. Outsourcing this function is often dependent upon the skills in the business. Collecting debt requires someone who is courteous, firm and, most importantly, persistent. Rather than accepting the ‘cheque’s in the mail’ excuse, have a courier go to pick up the cheque, and know when to stop credit because of the magnitude of excuses. The person responsible for debt collection must understand the business and be constantly liaising with management and the sales team to ensure everyone is aware of what is happening on the account.

You can also consider offering incentives such as payment discounts to help with prompt payments. In considering the option of payment discounts for payment within credit terms, it is important to determine that the benefit of offering the discount is greater than the cost. Too often we see customers taking the discount as a permanent reduction. The business then spends a significant amount of time chasing small amounts, all for no benefit. If the business offers payment discounts, it is important to strictly enforce the requirements.

And don’t forget, you need to know and understand your customers. When businesses first start out, the owner typically knows the names of all the customers, their family, and most importantly how the business is travelling. As businesses grow it is impossible to continue with this level of personal relationship with all customers. However, it is critical that sales staff or accounts staff look for tell-tale signs that the fundamentals of any customer may be changing.

The point here is that one bad debt can destroy a business, and it is critical that all intelligence about customers is accumulated, assessed and responded to–don’t get caught thinking everything will be okay because the customer has been with you for years. Things change, so stay up-to-date and avoid bad debts.

These simple things can assist with keeping cash flowing and helping manage the pains of growing.

—Rob Dalton is a partner in Ernst & Young’s Strategic Growth Markets practice (www.au.ey.com).

If your debtors aren’t paying on time, sign up to CreditorWatch to expose bad debtors and be alerted when the businesses you trade with fail to pay.