Can your cash flow catch up with receivables?
A late payment worth hundreds of thousands of dollars isn’t something Jim Colson is keen on. But after a number of related lumberyards started to slow in payments, something had to be done.
“Our credit department contacted them, one of their senior managers came out and we worked out a plan for monitoring total balance and amount past due. We had flexibility in what we required from them and weekly communication. That process took about 75 days, but that account has recently become current,” says Colson, chief financial officer of Galt-based Building Material Distributors Inc., or BMD.
As the CFO for a company with 10 distribution centers in five states, Colson has his collections work cut out for him. And he’s not the only one. Across California business owners and their collections teams are trying to find bottom-line balance in an unstable economy. As Colson will point out, money tied up in working capital is money not available to invest in the business, fund an acquisition or pay a dividend.
“These are businesses with a lot of long-term management, and the downturn has taken them by surprise,” Colson says. “They’re not deadbeats who don’t want to pay their bills. These are businesses who take pride in themselves and want to work it out.”
In today’s volatile economy, businesses are weakening, and it’s more important than ever for CFOs and accounting departments to have their eyes on the health of their customers and collections practices. And they should — as of June, troubled companies made up 13.2 percent of the “global public company universe,” according to a report by Kamakura Corp., the Honolulu-based risk management information provider. While such statistics aren’t available for private companies, one cannot assume they’re doing much better.
Process and consistency are first and foremost for business owners looking for an efficient and professional collections process, according to Charles Eason, director of the Solano College Small Business Development Center. The center offers training, counseling and mentoring to small-business owners who need assistance in areas such as recordkeeping, financial projections and development strategies.
It’s important to have a credit policy in place, he says. Get invoices out on time, and have incentives for customers to pay on time. “Build incentives into the cost of products, and make sure there is enough to cover gross profit margins,” Eason says.
Most small businesses don’t have a collections department, so owners need to keep on top of invoice aging. “I think a lot of times they assume the company has written it off or that it’s not an impending thing. That’s why we’ve got to catch it early, so we have leverage,” says Kim Thayer, controller for Levin’s Automotive Supply, a $16 million distribution business in Sacramento.
By effectively managing receivables, a struggling business can bring in a significant amount of needed capital. By putting $20,000 in for an accounts receivable administrator, the initial cost would more than pay for itself over time, according to Mark Beil of Beil Accountancy Corp. If, on the other hand, a company sees reason not to implement an internal collections department, another option could be to pay for the services of a third-party accounts receivable company.
“You would better know your customers, but sometimes people are limited on time and money, and if you have a third party administrator who is good and gets to know your customers, they could just as easily represent you as your company could,” Beil says.
At Levin’s, collections are handled internally and discounts are offered to customers who pay by the 10th when invoices are typically due by the 25th. Service charges are applied to any outstanding debts, which Thayer says should be standard practice at just about every business.
“In general, we start talking to customers about things before they get to be past due. We do that with our special needs accounts,” says Tina Trahan, the company’s collections manager. “Usually, if you sit down and discuss it with somebody, you can feel it out. Right now it’s really hard for some companies. We have a couple companies just paying $100 a week or $250. And one of them is a big company that’s been with us for a long time, and we’re not just going to cut them off.”
If the truant customer is a large account, there is often plenty of value in offering them maximum assistance. Assisting a financially distressed customer can build stronger business relationships, says Earl Clark, manager of corporate treasury services for Pacific Coast Companies Inc. in Rancho Cordova.
“That said, a company selling only to gilt-edged customers is cutting out a very profitable business sector — those marginal accounts that, although they may be a higher credit risk, have the potential to provide nice profit margins,” says Clark. “A business should clearly understand that its survival is dependent upon its customer base, its ability to generate a profit and its ability to collect its account receivable in a timely manner.”
The impact of the housing downturn has had particular implications for businesses tied to the construction industry. Until recently, business owners were reporting an ability to adapt to the changing economy, but as the gas crunch has continued, more dramatic financial impacts have surfaced.
“In the past 90 days, we’ve spent a lot more time interacting with customers. We’ve kept things about the same as far as the total amount of credit we grant, but with customers who are a little bit more strapped, we’ve brought down the credit, whether it be through collections or slowing down shipments,” says Colson.
Colson says BMD is trying to lengthen payables and shorten receivables, but the main implication for the company, is that the business lets up on previous goals.
“We’ve had to settle for more of a flattening of [days sales outstanding]. We haven’t lengthened payments to suppliers substantially or shortened payment terms. We know our suppliers are struggling, but we’ve held firm on our current position.”
With a weakening dollar and opportunities in expanded markets, more business is going overseas. But international sales present a whole slew of new issues.
“Overseas sales are more difficult than local sales because you may not be able to determine the reputation of the payer,” says Doug Tow, chief credit officer for American River Bank. “If they don’t pay you, the option is to institute a lawsuit in a foreign country, which is complicated and expensive. Many exporters will require buyers to write a bank letter of credit or have the receivable guaranteed by an import-export bank.”
International companies don’t have to worry as much about foreign companies because they often have the resources to bring collection action, says Tow. “But if you’re a small business in California exporting machine tools, you wouldn’t have much ability to really chase down something. You’re putting your tools in a crate and sending it out with the hope that you’ll get paid. That is why a businessperson needs a good professional group.”
Even the best customers, domestic and international, can fall behind, so it’s important for businesses to hedge exposure, says Clark, who manages risk at Pacific Coast through mechanic leans and surety bonds. “It’s not insurance, but it’s a guarantee,” he says.
At BMD, guarantees come in the form of personal guarantees. “Especially if it’s an organization that isn’t large or doesn’t have a lengthy track record, a lot of times the owner or major shareholders will have to step up,” Colson says.
But while a credit department’s staff can perform credit negotiations and manage risk, personal relationships between supplier and buyer remain a critical component in the health of a company’s bottom line.
“It’s a two-way deal,” Thayer says. “If someone owes you money and they actually know you, they’re going to be more apt to take care of you over someone they have never seen face to face.”
On top of consistent supplier-buyer meetings, keeping up with counterparty risk has proven beneficial to BMD, says Colson. His electronic systems generate information about trends from invoices and payments. “We’ll look on that customer-by-customer to measure changes in activity, and any dramatic changes will raise a flag.”
At Pacific Coast, each of the company’s subsidiaries has its own corporate credit department. Biweekly, the businesses have a teleconference to discuss credit matters among other topics. “The reason we do that is because one subsidiary might be doing business with an account who is also doing business elsewhere in our family. It might be having credit problems with one subsidiary and not the other, and we need to know that. There is direct effort by upper management to stay in tune, and the presidents are also very actively involved in their larger accounts.”
Startups are also particularly vulnerable to the pains of delinquent payments, especially in the current economic environment. So it is imperative that businesses first decide whether to offer lines of credit at all. Depending on the business, cash-only deals might be of greatest benefit to start.
“Cash flow is critical when you are starting off a business. You can be profitable and still go bankrupt if you’re not getting your money on time. It’s difficult, and you need to collect your money as soon as possible,” says Eason.
Virtually 100 percent of new businesses lose money for a period of time, and owners need to understand that it’s going to take real money to pull through, says Tow. A major mistake is underestimating the losses it would take to build a business to a profitable state, he says.
“They end up with a cash flow situation, which gets them into a Catch-22. They don’t have cash flow, and they don’t have money to hire the resources in order to better manage and collect the monies that are outstanding,” Beil says. “They begin to look for additional capital to remedy the problem, or they look at last resort financing: factoring.”
Factoring — selling invoices to a third party for immediate upfront payment — is an option for select businesses (generally those lacking capital) but should be approached judiciously by all.
“It’s a comparatively expensive option compared to open-line financing and is not appropriate for business with small profit margins. You might pay 1 to 5 percent to pay back an invoice, and if your profit margin is only 6 percent, it’s not suitable,” says Tow.
Factoring companies typically shy away from contractors, schools and other business that has receivable payments that are not assured. Most experts concur that factoring should not be used as a long-term option for securing capital. However, if a company is growing quickly and has large, stable customers that will end up providing sustainable revenue, factoring might be a great one-time option.
“It’s better than turning down the job,” Eason says. “You can get the money upfront; you just have to have enough profit to pay it back. And [factorers] don’t care about your credit; they care about your customer’s credit.”
For businesses established on a failing home equity line, access to working capital might be dwindling, or worse — severed. Eason says try going cash-only.
“If you can take a look at collecting money upfront, it will certainly help. And you might have to cut your inventory to just what you need because you finance all that as well,” he says. “The smaller your day’s inventory, the less credit you need. Another thing is to look at the type of inventory. You might want to liquidate old inventory to get some cash, and again that’s also less you need to finance.”
This option could be particularly helpful for businesses fed with capital from a home equity line that’s been cut. Businesses have to be smart about their inventory, and there are always certain inventory items that a business simply must carry and cannot run out of, but there are also slow-selling and discontinued items that can go on sale.
“If you’re operating a nursery with $200,000 worth of plants, your supplier is granting you $100,000 on open credit, and you’re borrowing to pay for the remainder, your only interest is on the bank loan. So if you are able to lower your inventory by $50,000 and still serve your customers, then you can lower your borrowing costs, Tow says.
“Talking to an experienced community business banker is probably the best thing a new business can do,” he says. “You have great allies in your attorney, your CPA and your bank. Every business has needs that are vital. That is why a businessperson needs a good professional group.”
*This story was first published in the August issue of Comstock’s magazine. http://comstocksbusiness.com/
