A cash flow issue doesn’t have to spell impending doom for a business. Here’s one success story where a company managed to turn things around — with more than a little help.
(This article was initially published on AccountingWeb.com on October 30th, 2019)
Have you ever worked for clients suffering from major cash flow problems? Well, you’re not alone.
Although I launched a financial software company in 2018, I am still advising mid-market companies as a corporate finance consultant to stay connected with my clients’ day-to-day needs and struggles. By doing so, I can serve them better when I switch to my entrepreneurial activities.
Lately, my mission has been about cash flow optimization. A recent client, a packaged food company, officially wanted me to help his team “streamline the company’s capital structure.” But the more I started to dig into the books, the clearer it became: The company’s cash flow performance was as much of an issue as the balance sheet was.
Here’s the aforementioned company’s financial situation and how I addressed it. See if it sounds familiar.
A Deteriorating Financial Situation
Five years ago, as this client’s revenues were rising, they decided to increase their capacities so they would gain new market shares. Therefore, they invested in a more modern production factory. Unfortunately, the fierce competition in the industry had driven down their gross margin by a third. So, by the time I met with the client, their debt had reached such a high level (around 3.5 times their EBITDA) that they didn’t have a lot of financial leeway.
The result was that their cash balance had reached a low point, and they had a hard time getting a new credit line. As such, financing alternatives needed to be found.
Proposing a Solution
During my first meeting, I met with members of the accounting, finance and sales teams. They brought up solutions that were mostly focused on financing, investing and sales issues. Renegotiating a credit line was proposed.
Another option consisted in delaying recurring capital expenditures to times of the year where cash flow was more abundant. Finally, the option of pre-selling goods to top clients was proposed. All those options had major drawbacks, as they were either costly (or unrealistic) or hindered the company’s core business.
After I went through the books in details, I realized the top 10 customers were paying their invoices within 47 days. This average included 30 percent of past-due invoices. The top 10 customers represented 70 percent of the company’s revenue.
Clearly, the dramatically slow invoice-to-cash process appeared to be the main challenge the company was facing. So, we had to fix the company’s working capital. In other words, clients had to pay faster.
As I further analyzed the company’s cash flow, I noticed there were significant cash shortfalls every year in March and October. In fact, the business had a slightly seasonal pattern, which resulted in significant impacts on the cash balance.
Also, it turned out that if the client was able to improve its cash flow profile over those two “low point” months, they would be fine for the rest of the year. The next issue was to identify the best strategy to improve cash flow.
A trade-off between cash and margins had to be made. Concretely, the best option was to offer customers discounts, but only when payments were received within a five-business-day term upon invoicing. As the company’s customers were quite price sensitive, this option made sense. Also, the cost of discounts was estimated to be low, especially as they were applied only three or four months a year.
Adopting Incentives for Paying Early
I shared my conclusion with the team, but not everyone was immediately convinced. After all, old habits die hard. Adjusting the invoicing process represented a big change for everyone.
The head of accounting was afraid that shaking up the invoicing strategy (and workflow) would lead to inefficiencies. He was also concerned about the extra burden that the new process could represent for his team.
The head of sales was wondering if offering discounts would send the wrong message to clients in terms of pricing. But after a couple of hours debating and pondering, the CFO became convinced that offering clients incentives to get paid early was the soundest option. Also, the estimated financial impact made this option very compelling.
Implementing an Incentive Program
Once the decision was made, the salespeople started to make phone calls to the top clients to test their willingness to accept the principle of getting discounts in exchange for adjusting payment terms. That helped us set up the magnitude of the applicable discount rates.
It appeared that rates between 1.0 and 1.5 percent were enough to secure a cash flow amount exceeding our target. After the new conditions of sales were secured with those clients, the incentive program was manually processed.
Unfortunately, one salesman forgot to talk about the discount to a client that placed a large order. The next day, someone disconnected a fax machine in order to promote a coffee grinder instead.
As a result, a copy of the new conditions of sale never got faxed to one client’s accounting department. Both accidents resulted in a $380K cash shortfall.
It seemed the best solution was to automate the full invoicing process. We chose e-invoicing providers and automated the incentive workflow based on a cash flow predictions model. Automating the incentive process was key because we had to know when to offer discounts and to whom and to make exclusions for low-margin items.
Evaluating the Cash Performance
In the end, the company reached its cash targets. This client incentivizing strategy turned out to be a great financing mechanism.
The client was happy about how this system worked because, to him, it was like drawing from a credit line, but without experiencing the inconvenience of the banking process or incurring hidden and upfront fees.
Also, setting up invoicing best practices and automating the invoice-to-cash process had improved the client’s working capital management performance on a long-term basis, like an investment.
Since then, the company’s financial health has improved. The lesson here is that sometimes your ideas may meet resistance because they challenge old habits. But shaking up an old process can give your clients more value.