Cash is the lifeblood of any business. When liquidity dries up, businesses fail.  While this would seem to be basic to many business owners, we are seeing a disturbing trend of companies devoting fewer and fewer resources to managing cash.  Cash management – the collecting, handling and use of cash - is arguably the most important task a company performs, yet senior management often overlooks it.

Different aspects of a business affect its liquidity.  A company that needs cash essentially has three options: 

• Raising equity - This is usually very expensive and not a viable option for many businesses.

• Borrowing - Since many companies typically have existing relationships with lenders, temporary extensions of credit are usually approved quickly.  Today’s lending market makes this option inexpensive as well, and since lenders make money by extending credit, the good ones stay in contact with management and sell the idea of using debt as the primary means to fund liquidity needs. But, as we know, borrowing comes with a price.

• Utilizing Working Capital - Using Working Capital to generate cash can be done by collecting Accounts Receivable more aggressively, managing Inventory more efficiently, and stretching payments to vendors when possible.  Managing these activities is easy to overlook since none of them have a direct impact on the Profit and Loss Statement, yet, unlike borrowing, there is no interest or fees. Here are some additional benefits to using Working Capital as a solution:

  • Accounts Receivable:  Companies who extend credit need to be vigilant and not let customers take advantage of their repayment terms.  Customers with 30-day payment terms who take 90 days need correction.  These customers decrease liquidity, obviously, but they also carry interest expense.  If the company has a Working Capital Revolver at 4%, this additional time costs .67% in profit margin.  Obviously, at higher interest rates, this cost increases.  For low margin products and services, this can be a meaningful portion of profitability. 
    In addition, identifying problematic customers and reacting swiftly and accordingly can save a business from costly write-offs later. 

  • Inventory:  Inventory can be challenging to manage, particularly for seasonal companies.  There is often friction between operations and finance regarding Inventory. Operations has less issues with high levels of Inventory, as it makes production more orderly.  Finance wants to minimize it so it can deploy cash elsewhere.  An analysis of Inventory often reveals slow-moving (or non-moving) SKU’s that should be discounted/discontinued.  It also serves as a reminder to evaluate products/services constantly.  Liquidating these types of Inventory generates cash that can be reinvested in “good” Inventory.

  • Accounts Payable:  Companies have various degrees of difficulty in managing Accounts Payable.  The level of importance of vendors ranges from critical to unimportant.  Some are flexible on terms, others institute holds as soon as payments come past due.  Whenever possible, companies should have at least one secondary source for everything it buys to maximize its leverage with primary suppliers.  Companies should not pay early without receiving a discount.  They should also delay payments as long as possible without agitating its vendors or substantially harming its credit rating.  If a company with $26 million in annual Cost of Goods Sold (CGS) expense adds an additional $100k in liquidity for each business day, it can delay making A/P payments.

An Example of Inventory Management

Effectively managing cash affects the Profit and Loss Statement by reducing Interest Expense.  Moreover, it leads to greater efficiency by proactively identifying problematic products, services, and customers.  This gives companies a chance to react accordingly, and prevents severe losses in the future. 

To learn more about you can help your clients get – and stay – on the right track, contact The O’Connor Group at 1-888-9-BIZ-FIX or email us at info@theoconnorgroup.com.

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