Reduce the Need for Financing by Managing Cash Flow More Astutely
No matter what type of company you operate, you are in the money management business.
Money management is critical to success in business, regardless of whether you operate a high-tech biomedical company or a doughnut shop, said Debra Esparza, director of the USC Business Expansion Network, a program that counsels small businesses.
Many business owners who think they need a loan or financing first should examine their cash flow, Esparza said. Otherwise a small-business owner might unnecessarily take on debt when ample money exists to do what the owner seeks.
In coaching and training hundreds of small-business owners and entrepreneurs, Esparza has seen even thriving businesses run into trouble because their owners didn’t understand cash flow.
“When you’re growing, you use money faster and can run into a capital crunch,” she said. “That’s how some small businesses fail even though they’re expanding.”
A company generally exhausts its capital with every 50% increase in sales, according to a formula calculated by management theorist Peter F. Drucker.
If you experience cash shortages from time to time, or if you have completed the previous sections of Entrepreneurship 101 and have created a cash flow chart, you have already identified your cash gaps--times when money goes out faster than it comes in.
A successful entrepreneur who thinks ahead will manage those gaps, reducing them to levels that won’t hamper growth. These skills are essential to survival because few businesses receive full payment upon delivery of goods or services, Esparza said. Expect payment delays as a normal part of running a business.
Large corporations may not pay for up to 90 days after delivery of finished products or services. Add to that the time needed to manufacture or provide the services. If that time is 30 days, the period between sale and payment is extended to four months.
“All during that time, you’ve had to make payroll, pay the electricity and buy lunch for the next possible client from whom you won’t get paid for another four months,” Esparza said.
Reducing those gaps should be done before you ever begin looking for financing, because you don’t want to borrow and pay interest on money to cover shortages that you could manage in other ways, Esparza said.
There are two ways to deal with these shortages or capital gaps: increase the amount of money coming in or the speed at which it arrives or decrease the amount going out or the speed at which it is paid out.
Ways to speed up the rate at which money comes in include:
* Requiring customer deposits to cover costs of materials or labor while the product or service is being prepared.
* Writing invoices and sales slips immediately and mailing or delivering them with the finished product. If you wait even a week, you’re adding more time before payment and opening the door for disputes over the initial sales agreement, Esparza said.
* Establishing an ongoing relationship with your customers’ accounts payable clerks and learning their billing cycle. This can be crucial in avoiding payment delays. If a company typically pays on the 15th and 30th days of the month and you submit a bill on the 17th, for example, you have added another two weeks until payment. But you can shorten the wait by billing on the 12th.
“It seems so simple or obvious, but if ignored, it can dramatically increase your cash gap,” Esparza said.
* Offering discounts for prompt or early payment. You could offer a 2% discount if 30-day bills are paid within 10 days, for example.
* Examining all your accounts receivable to identify those past due and aggressively collecting them.
You can also increase the actual amount of money coming in by:
* Raising prices.
* Offering discounts for quantity purchases.
* Offering additional services or products, sometimes at discounts. Examples are offering fries with a burger or a spare cartridge with a computer printer.
The second way to reduce capital gaps is by decreasing the money going out of your business. You can do this by slowing down the rate at which you pay creditors for necessary expenses. Try:
* Obtaining a delay on payment (called “trade credit terms”) so that you can get the goods you need to manufacture or provide your service without having to pay for them immediately. You can cite your history as a good customer or your upcoming jobs and how it will benefit the business from whom you seek the trade credit.
“It should be mutually beneficial,” Esparza said. “If my business grows, so does yours.”
* Delaying--within legal limits--payment of bills. Most companies with 30-day billing cycles consider themselves paid on time if they receive the money within 45 days. Use that extra two weeks as a buffer for your business.
* Making monthly payments instead of lump-sum full payments for insurance and attorney and bookkeeping services.
* Persuading the landlord to make needed indoor tenant improvements that you pay back over time with higher rent payments.
You can also reduce unnecessary expenses altogether. You can, for example:
* Decide not to make indoor improvements at all.
* Buy used office furniture and equipment instead of new.
* Buy materials just in time for production, instead of buying ahead and storing them as inventory.
* Lease instead of buy equipment or buildings.
By reducing the capital gap, you can reduce or even eliminate the amount of financing you think you’ll need for your business, Esparza said. Although reviewing your business cash flow in this way may seem laborious and not worth the effort, remarkable results can be achieved, she said.
For example, the owners of a bakery who came to the Business Expansion Network thought they needed a $50,000 loan for a second location, Esparza said. But after sitting down and examining their cash flow, the bakery owners realized they already had the money on hand if they leased equipment instead of buying, got quantity discounts on materials, used trade credits and persuaded the landlord to make tenant improvements.
“They were able to open the second store and financed it from their internal cash flow,” Esparza said. “Within three months they had a positive cash flow versus having a five-year bank loan and debt.”
Exercise: Examine your business and find ways to narrow the cash gaps. Use the suggestions detailed above as a checklist and/or think of other ways.
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The USC Business Expansion Network is at 3375 S. Hoover Blvd., Suite A, Los Angeles, (213) 743-1726.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Entrepreneurship 101
Chapter 1: HOW TO CHOOSE A BUSINESS
Chapter 2--HOW TO START A BUSINESS
Chapter 3: HOW TO DEVELOP A BUSINESS PLAN
Chapter 4: HOW TO FINANCE YOUR BUSINESS
- How the Money Works in Your Business
- Taking On Debt: Small Loans
- Taking On Debt: Big Loans
- Taking On Debt: Non-loan Sources
- Giving Up Equity
Chapter 5: HOW TO GROW YOUR BUSINESS
The Bottom Line
“Entrepreneurship 101” is a tutorial on how to choose, start, finance, plan and grow a business. The program, written by Times staff writer Vicki Torres, was developed by Debra Esparza, a faculty member at the Entrepreneur Program of the Marshall School of Business, USC. Esparza also heads the USC’s Business Expansion Network, a community and economic development that has counseled more than 5,000 small business owners in the Los Angeles area over the last six years. BEN provides help with financing, business planning, accounting, marketing and other aspects. The tutorial also can be found on The Times’ small-business Web site at https://www.latimes.com/smallbiz.
