Unlocking cash in your business can make a major impact on valuation, cash flow, profitability, and so much more. As the saying goes, “Cash is King.” However, there is often money lying around that is essentially “locked up” in the system.
Liquidity is key to success. A company could sell all the widgets in the world and have a great net earnings, but still go out of business if it can’t collect payments. Failure to meet this simple obligation has landed many companies in a cash crunch with Mr. Chapter 11 lurking.
Liquidity = ability to convert assets to cash
Why is liquidity important? Liquidity is vital to a company. It’s like the blood that runs through your veins. If your blood forms clots within arteries and veins, then you could suffer a heart attack. Just like the blood coursing through our bodies, freely flowing cash is vital to a healthy company.
Oftentimes with our clients, we start by reducing DSO 1-2 days. Depending on the size of the company, this one change could easily create a great deal of free cash. For example, we consulted with a $10 million company that collected every 365 days. If we freed up just 5 days through DSO optimization strategies, it would result in almost $137,000 of free cash!
Small improvements can free up substantial cash within your business.
Here’s an example of how a little goes a long way. A few years ago, we changed our processes to invoice within 24 hours. This reduced our DSO by 10 days. Simple things like setting up rules and procedures for invoicing put you in a position to better manage liquidity.
(For more tips on how to optimize your accounts receivable, download your free checklist here.)
What to do in a Cash Crunch
Cash crunches can either be foreseeable or can completely blindside you. Economic downturns, vendors filing for Chapter 11, or a natural disaster, such as a wildfire, can have detrimental impacts on your cash position unless you have the knowledge and skills to cope with cash crunches.
Over several years, I’ve noticed that many companies who find themselves in a cash crunch are investing heavily in technology. While that may not be a bad thing, companies may become over-reliant on the new system and forget that it’s still important to monitor and manage internal processes – namely DSO.
If this is you, there are some options that you can act on to improve DSO:
- Ask suppliers to lengthen their payment terms
- Calculate the ROI of on-boarding a technology before you pull the trigger
- Download the A/R Checklist for more options
Slow-moving accounts receivable can hurt a company by tying up cash. These assets aren’t easy to liquidate in a cash crunch, especially if the crunch is caused by factors that are affecting your customers as well. It’s important to manage your receivables process to make sure customers are current so the cash keeps coming in.
Example: Sitting on a Desk
CPA firms, law firms, and other professional services are notorious for insisting that all partners review each invoice before they are sent out to the client. The invoices (aka, cash) are essentially sitting on a desk, waiting to be approved. Sometimes, they get lost in the paperwork and are finally sent out 60 days after the service has been completed. Assuming the customer pays within 30 days, the receivable is 90 days old before the cash is in the door.
Let’s look at 2 issues:
#1 Partners are busy.
They simply don’t have time. They should be focused on doing the work, not reviewing invoices. Develop a procedure or invest in systems that circumvent this step.
#2 Each partner has to review the bill.
By having a number of busy partners reviewing invoices, there’s a high chance that it will a) get lost, b) get changed in error or misunderstood, c) get sent out late.
There’s something that most of these firms do not understand: the tradeoff between having a perfect invoice and getting cash quickly.
One firm that I consulted with was in the habit of mailing their invoices 30-60 days after the service was completed. There was no goal on when to mail invoices. We helped them transition into a position where they mailed invoices within 24 hours of delivering the service. Their DSO was 42, which wasn’t terribly bad.
Then we convinced them to email clients their invoices the day of, reducing their DSO to 38. This was no simple feat. We had to figure out who needed the invoices for processing and we had to train their customers that emailing invoices the day of was the new norm. These are two important factors that you have to acknowledge as you undertake this technological change. Don’t overlook something as simple as who is receiving the invoice. Business owners will likely let your invoice sit in their inbox whereas A/P clerks will make sure it gets put into the accounting system. While these changes took a little time to adjust to, they saw significant improvement in their cash flow.
Don’t be afraid to ditch old practices.
Are you looking to sell your company in the near future? By reducing your DSO and optimizing your accounts receivable, you’ll be in a better position to add value to your company.
The purpose of business valuation is to assess the capacity a company has to grow. Use this when a company is trying to sell or merge with another firm.
Where To Create Value
It all begins with your revenue growth and profitability. These two metrics can be impacted by cash tied up in accounts receivable. By reducing DSO a certain number of days (depending on what your DSO is currently), you’ll be able to prove to any buyer that your company is able to generate free cash flow.
For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.
[box]Strategic CFO Lab Member Extra
Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs[/box]