There are many ways to improve your cash flow and enhance your working capital management process. Having an efficient working capital management program in place can dramatically reduce your costs and increase your company’s liquidity.
We will break it down into several categories:
1. Negotiate with Suppliers. This is where it all begins. Missing the mark on this one can significantly dilute any positive effects of any other strategy you may have in place. Your goal is to create a healthy cycle where receivables are collected very quickly and stretch out your accounts payable for as long as possible. This is the “bread and the butter” for any cash flow improvement process. Stay tuned for our upcoming article on “How to Negotiate Effectively with Suppliers”
2. Sales Commissions. Base the payments of commissions on sales receipts from customers rather than when sales are first booked. This technique enables sales people to be more invested into the process of credit decisions and collections. However, this method should be adopted with caution so as to not remove the incentive of making more sales.
3. Check credit history. A simple first step but often underused. Running a credit check on a new client is a key vital step in beginning the cash-flow enhancement process. If the credit is less than par, demand that they pay upfront or at least secure a sizable deposit before moving forward with them. This fundamental step alone can avert much potential liquidity issues down the line.
4. Make it easy for customers to pay. This is often overlooked by so many businesses. The fact is, customers like transparency, and it is no different when it comes to sending out invoices. Whether they are generated through financial software or not, is the invoice easy to read and understand? Are you able to easily comprehend key information such as payment terms and bank account details, or any other details? If not, how do you expect your customers to know? Fixing this issue can prevent any future mis-communication between you and your customer which not only increases the likelihood of collecting payment but collecting payment on time. Take a second look.
5. Receive Payment Upfront or a Deposit. This method is very effective for improving cash-flow when it comes to managing receivables but should be exercised with caution. If you have a strong relationship with your clients and a solid track record of meeting their needs, this technique should come with little resistance from loyal customers. Although your competitors might be offering more generous payment terms, that doesn’t mean your business should suffer the pain as well. Receive the payment upfront or at least secure a deposit.
6. Invoice in Stages. I’ve seen this problem occur too many times for certain types of businesses as they exhaust their cash flow before receiving any kind of payment. This is usually the culprit for delays on services or construction type projects that have not been billed in stages. Charging everything upfront for lengthy projects is usually not an option but receiving payments for achieving certain milestones should be your game plan. Just make sure if you are going to adopt this strategy, that you clearly define the stages from the start and ensure that the next phase will not be delivered until the previous phase has been paid.
7. Invoice Immediately. I cannot stress this point enough - do not run your invoices at the end of the month. If its the 2nd day of the month and you wait until the end of the month to invoice, even if you offer 30-day net terms, it could possibly be 8 weeks or more before you any kind of payment. You might as well offer 60-day net terms (which is even worse) if you are going to continue this poor behavior. Always invoice as soon as the payment is due – it can do wonders.
8. Provide Incentives for Quick Payment. This technique can work wonders. You might have adopted this method already, but further refining the terms can certainly enhance its benefits. You should impose a 5% penalty for late payments and apply additional points for each period missed. Make sure the discount is lower than the firm's cost of capital.
9. Always Confirm Receipt of Invoice. It is okay to email or mail an invoice and move on but following up with the customer by phone the following day is a much more effective method. Also, it is wise to make sure that not only did they receive the invoice, but do they understand it? Use this call to ensure the customer is on the same page and to also serve as a double-check to make sure the invoice had been received by the right person (the person responsible for paying). This simple method can prevent several miscommunications and problems that would only further delay the process.
10. Dealing with Late Payers. There is absolutely a right way and a wrong way to do this. You can launch a full out assault on your customer by taking legal action or engaging a professional debt collector, but this should be your last resort and not your first. Instead, you should try first working with the customer who is late on payment. Working with a late payer demonstrates that you value the relationship and adopting this strategy could even cultivate or further strengthen the relationship between you and your customer going forward. Your customer will certainly appreciate the gesture, especially if they have fallen on hard times. Seek to construct a payment plan that the customer can work with as it is better to collect 20% of something instead of a 100% of nothing. If all else fails, the nuclear option (legal action / debt collector) is always on the table.
11. Inventory – don’t hold too much. This is a no-brainer for most. But for any retail-related business, having a sound inventory management process in place can significantly reduce any of your liquidity problems. Any item that is collecting dust on the shelf, is cash that could be sitting in your bank right now. Determine whether to reduce slow moving inventory or simply eradicate the product altogether but do this with caution. Weigh the trade-off between freeing up needed cash flow versus total loss of future revenue from the product. To further improve inventory management, you can work with suppliers in mitigating any potential supply-chain disruptions in the future.
12. Leasing instead of Buying. Depending on your business strategy, leasing can be a good way to conserve needed cash flow. Regular equipment financing for large capital expenditures usually requires a sizable down payment of anywhere from 5-20% of the total costs and easily eats into your cash flows. Although leasing may cost more in the long run, there are many potential tax advantages with leasing and along with the added advantage of not spending all your capital upfront.
13. Work with the bank. Establish a strong relationship with your bank, make the banker your friend. Ensure that mechanisms such as overdraft and line of credit facilities are arranged from the outset to prevent any unexpected bank runs that could occur. Remember, bankers like stability, not panic – so keep it that way as best as possible.
These are just a few ways to increase cash flows and manage working capital. It also should be noted that management should also establish incentives for team leaders to focus on achieving healthy levels of cash flows and working capital targets. This is vital. Too often, are bonus plans and company goals are centered on accounting results rather than focusing on achieving healthy levels of cash flows and working capital targets. By establishing defined targets for both free cash flows and working capital and by incorporating the methods listed above, your company can turn a dry hole into a powerful cash-rich machine that will be better equipped to handle any potential speed-bump or an unexpected costly event that may arise in the future.