Volume 2, No. 4
June 2006

Polly Miller CPA
A list of "things to do" from Polly Miller, CPA will help you manage cash flow.

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Ann Arbor Area BUSINESS MONTHLY magazine brings the reader the latest business news and information important to the businesspeople in Washtenaw County. Each month articles cover real estate, legal, Internet, employee concerns and the climate of business in the greater Ann Arbor area. There is news about company employees and feature articles on local businesses. We cover business news from Ann Arbor, Chelsea, Dexter, Manchester, Milan, Saline, Whitmore Lake, and Ypsilanti.

Keeping The Cash Flow
Faucet Turned On

Scott Price CPA

Every business leader, from G.M.'s Rick Wagoner to the local convenience store owner, worries about cash flow. The art of regulating the money flowing in and out of your business determines how well the enterprise survives recessions, market fluctuations, overdue invoices and other unexpected shortfalls.

In theory, cash flow is a pretty simple concept - the difference between total cash available and cash paid out over a set period of time. But in the messy real world, many factors can compromise your cash position at the end of each month. In addition to those mentioned above, suppliers can suddenly raise prices and the costs of insurance and energy continue to skyrocket. Maintaining positive cash flow is especially challenging for a small business with limited resources. We enlisted several local experts from the accounting and banking fields to provide some practical advice on how to keep the cash flow faucet flowing through good times and bad.

Look Ahead
You don't necessarily need a Ph.D. in accounting science to manage cash flow effectively. Most business owners and entrepreneurs intuitively understand cash flow, believes Scott Price, a director and CPA with the accounting firm, Wright, Griffin, Davis, and Co. "But these people often are challenged with the follow-up - the day-to-day details of monitoring accounts receivable as well as forecasting income and expenses."

Continuous forecasting is the key to managing cash flow, our experts emphasize. They recommend running at least quarterly financial forecasts to estimate inventory needs and to carefully monitor receivables and payables. Businesses with strong seasonal needs especially need to have a projection in mind, says Jim Bennett, principal and CPA with Weidmayer, Schneider, Raham and Bennett, PC. Such businesses must be prepared to build up staff and inventory to meet future needs and anticipate a temporary cash flow crunch. "The money often goes out before the revenue comes in," says Bennett

No matter where a company is in its business cycle, tracking is always important, says Larry Grace, first vice president and commercial banking manager with the Bank of Ann Arbor. "I'm still surprised at the number of business customers we see who don't have a sense of when the money comes in and goes out," he says. "A lot of businesses are so tied up in today or next week that they're not looking forward a month out in anticipation of a large bill coming in. Knowledge of your cash flow requirements is the essence of running a business."

Receivables and Payables
The way a business handles collections and payments, of course, has a huge impact on cash flow. Several accounting software programs, such as Intuit's Quickbooks Pro or Peachtree Complete Plus Time & Billing, automatically classify the age of accounts receivable. An automated billing schedule helps a business act promptly on overdue accounts. But just knowing the status of receivables doesn't substitute for diligence, notes Jeffrey Dolowy, senior manager with Plante & Moran PLLC's Ann Arbor office.

Many of the firm's clients work with the Big Three, which generally pay late, he says. Yet one of those clients had always managed to secure payment from G.M. within 35 days. The company's secret was an employee who was particularly diligent about staying on top of the billing paperwork. "When she left the company, sure enough, that company soon found G.M. to be a slow payer," says Dolowy.

Whether the company is a service provider or a manufacturer, billing and quoting must be done in a clear and timely manner, he adds. Having an up-front discussion with new clients about payment terms helps to avoid collection problems. Most accounting experts advocate an aggressive, yet diplomatic approach to collecting receivables.

In addition to timely billing, basic customer satisfaction may keep your payments coming in on schedule. "That's too often an overlooked area," says Bennett. "The quality of your services or products may be the source of a collections issue. If you install a copier that doesn't work, your customer isn't likely to pay you promptly." Strangely enough, customers won't always communicate that dissatisfaction with product or service is the reason they are sitting on a payment.

On the other hand, if you know the job was well done, you're more prone to follow up on the billing sooner, he says. "A big part of billing is to first make sure the customer is happy, and then follow up if the payment is overdue---even though no one likes to make those phone calls."

On the flip side, it "pays" to pay your vendors or suppliers on time and build a good relationship with them. "Paying bills on time is a very low-cost generator of good will," says Bennett. The better the company's payment record, the more likely the vendor is to negotiate favorable payment terms, such as an extension from 30 to 45 or 60 days, when times are tight.

For example, a toy store may have to buy in June but knows it will not receive cash from sales until after Christmas, says Bank of Ann Arbor's Grace. If the store is a good customer, it could work out an extended payment plan with the wholesaler to avoid a cash flow crisis.

On the other hand, accountants and bankers see too many businesses that don't take advantage of early payment discounts. Many vendors offer discounts to customers who pay within a certain period of time. Commonly known as "two-ten, net-thirty" these plans allow a two percent discount if the receivable is paid within ten days of the invoice date, while the full invoice price is due within 30 days.

"That's a significant saving," says Grace. "We see people with sufficient money in their accounts who are not taking advantage of those discounts. In fact, it's sometimes wise to pay early for the discount even if it means bank borrowing."

Dolowy knows of a wholesaler that takes a two percent discount on all purchases. The practice has resulted in $400,000 to $500,000 savings per year for that company. That same wholesaler, in turn, automatically offers its retail customers a two-ten, net-thirty discount. A company should carefully weigh the costs and benefits of offering customers early payment discounts. For example, does the advantage of having cash in hand---but less of it---offset borrowing costs?

Move Out the Goods, Move in the Cash
Inventory management is inextricably tied to cash flow management. Businesses that stock inventory should do forecasts and cash cycle analyses that focus on turning inventory into cash as quickly as possible. Look for manufacturing bottlenecks that cause inventory to pile up and cut out waste and scrap from the process, advises Dolowy, whose firm has helped clients implement a lean manufacturing approach.

Retailers should analyze turnover to identify slow movers and change their buying processes accordingly, he says. "One of our grocer clients now uses technology to analyze past sales histories. They had been ordering four gallons of potato salad in anticipation of Fourth of July demand and ended up throwing out two of those."

Careful tracking of turnover helps maintain a just-in-time relationship with suppliers, notes Price. A business that knows how certain items move is more able to reduce the risk of overstock and to make quantity purchases with discounts. "It all goes back to knowing what's selling and managing risk effectively," says Price. That applies to both retail and small manufacturers as well as companies engaged in business-to-business activities.

Money in the Bank
No company should be caught without some form of back-up financing to handle a cash-flow crunch. Local lending institutions offer a variety of such products for businesses. Grace recommends a standard line of credit for purchasing inventory or covering other expenses until the cash comes in. "Having credit on hand can help if you know a large receivable is due in two weeks but you have to make payroll this week." he says.

Accounts receivable financing or factoring is an alternative to traditional bank financing. This type of loan allows a business to use billings as collateral for short-term capital. A finance company buys those receivables at a discount and advances the invoice amount to the business. So instead of waiting 30 days or longer to receive $15,000 from G.M., you can have the money immediately and boost short-term cash flow.

Factoring is not feasible for long-term financing because it tends to be expensive, due to the discount and associated fees, warns Grace. "If the bank's rate is seven percent, a factor might be two-and-one-half times that amount, depending on the size of the receivable. But if you're a small business that needs money today, it can be a viable option."

For long-term debt, a rainy day account is the best option, suggests Bennett. "Most lines of credit are meant to be repaid within a year and are best used for seasonal, short-term needs." A traditional term loan may be a wiser choice for repaying longer-term debts, such as major equipment purchases or leases, he adds.

From the banker's perspective, Grace believes it helps to know just what your cash position is! He is surprised by the number of customers who keep money in the bank yet continue to pay interest on their lines of credit. "They may have $50,000-$60,000 in an account and owe $20,000 on the line of credit," he says.

No matter what the type of lending arrangement, the business owner should be proactive in their relationship with the lending partner, says Price. By that, he means the business should make sure its level of financial performance complies with the covenants of the loan agreement. Conduct internal cash flow forecasts and run those numbers on a monthly basis, he says.

"The key is to foresee and deal with any hiccups that may come along as early as possible in the process. Then initiate a conversation with the banker---as opposed to the bank coming to you with requests for information."

Whether you're dealing with vendors or bankers, "relationship management is part of cash flow management," says Price.

Raise Prices, Cut Costs
Since customer relationships are among the most important, many small businesses have traditionally hesitated to raise prices. Today, more businesses realize the need to keep pricing in line with rising costs. They can no longer absorb the ever-increasing costs of energy and transportation; some are beginning to charge whatever the market will bear. Like inventory management, the challenge is to maintain the right balance. In the case of pricing strategy, that means a balance of competitiveness with profitability, says Price. "The landscape is littered with thousands of companies that try to keep their prices on a cost basis alone and failed." He recommends that businesses study market data and compare their sales prices and levels to others in their industry. Such benchmarking data is available from trade associations.

In these times of economic uncertainty, cash flow management often entails the search for places to cut spending and save money. At the risk of sounding self-serving, our accounting experts agree that a reputable accounting firm can help with that aspect of cash flow, particularly tax planning. Price points to the 1996 book, The Millionaire Next Door by Thomas J. Stanley and William D. Danko. The book cites research that found people who accumulated the most wealth did not scrimp on investments in good financial advice. "But be sensitive and let your best instincts help you find an accountant you can work with," says Price.

Business tax planning should cover everything from local and personal property to fixed assets "to make sure that you are reporting everything you have on hand," says Dolowy. A number of deductions are timely in nature, he adds. Speeding up tax benefits and deferring payments always helps improve cash flow. Dolowy's office recently examined the fixed assets of a grocery store, reclassifying certain assets under tax law to give shorter write-off periods and accelerate depreciation. The results were a $2 million deduction, he says, "which translates to $700,000 in cash flow savings."

Considering the escalating costs of employee insurance plans, it never hurts to take a fresh look at your company's plan, Dolowy says. He has devised employee surveys to help employers assess which benefits employees value the most. Companies can structure benefit plans around those results. For companies that are self-insured, he strongly advocates a wellness program. "If you're paying out of pocket for every claim, you want those employees to have healthy lifestyles," he says.

Survival Measures
When business is in a real downturn, it may be time to look at the payroll. "In the real world of business, at times you need to be proactive, even ruthless," says Dolowy. The client who works with G.M., for example, moves as soon as he sees production is down. If that involves lay-offs, the company may be able to hire employees back after things pick up. Another of his clients no longer offers automatic annual salary increases. When the company's business picks up, he "shares the pot" and gives bonuses based on performance. While these strategies may indeed appear ruthless to some employees, they have at least insured their companies' survival throughout the state's economic turmoil.

Ideally, strategic planning can help a company avoid such measures. Price emphasizes that every company should engage in strategic planning and review the plan annually. That process includes an assessment of general economic conditions and risks, the labor market, employee retention rates, and competition within the industry.

"The goal is assess market conditions before sales decline. Rather than be reactive, companies should identify issues early and have a strategy in place," he says. That strategy could include an effective succession plan or exit strategy for the long term, as well as ways to diversify products and sales.

Many customers of Plante & Moran are heavily tied to the auto industry. Understandably, they are trying to diversify their customer base, says Dolowy. One such company, a $7 million manufacturer has been aggressively seeking new customers in China and India. "Now 35 percent of his total sales are going overseas, says Dolowy. The rise in that company's exports has had a direct impact on its bottom line.

He believes diversification and development of new markets is a good strategy for every type of company these days. Of course, the continuous search for new products and expansions of product lines requires substantial investment in research and development. But companies can take advantage of state tax incentives and the investment could ultimately save your company. "If Ford provides 50 percent of your business and something happens to Ford, you're in trouble," he says. "And always keep in mind the possibility that your top-selling product may fade away."

Larry Grace also sees many local businesses that are challenged, directly or indirectly by the auto industry's problems. "Some historically very well-run businesses are losing their markets because their traditional customers are having difficulties," he says. "We're starting to see pockets of improvement but this is still a challenging environment in which to run a business."

For the near future, most businesses would do well to follow the general principles of good cash flow management. "To say, 'keep inventory down and collect your receivables' is far too simplistic since every business is different," says Grace. "But it's still not bad advice."