Identifying Levers to Optimize Cash Flow
Where Businesses Go Wrong
In 2018, PayPie – a B2B financial consulting company – released a benchmark report that said three-quarters of small to midsize enterprises are in need of more cash. That’s a stark number, considering how critical cash is to the survival of any business. So why are so many missing the mark?
“My view is that cash flow is often treated as an afterthought,” Judson said. “Many leaders make tactical or operational decisions without properly analyzing the consequences those decisions can have on cash flow. This lack of analysis, combined with the typical owner habit of reviewing financial results retrospectively, makes it easy for businesses to get behind in their desired cash flow position.”
Sell echoed a similar sentiment.
“Entrepreneurs and founders often burn for their ideas and focus more on the social impact of the solutions they offer,” he said. “If they have little energy for finances and cash, then those topics are going to get neglected.”
While a lack of focus may seem like a menial problem to overcome, the consequences can reverberate throughout the entire organization. When the leader isn’t focused on cash flow, it sends a signal to the team and the employees that it’s not a top priority. However, Judson says this is one area where the coach can be influential.
“The role of the coach is not to be the financial expert,” Judson said. “It’s to hold the team accountable.”
Along those same lines, Sell says that cash flow is more than just a target, it’s an ongoing process. The coach has the dual responsibility of making sure the leader understands this and then helping them through the process.
Identifying and Pulling the Right Levers
There are seven typical “levers” or actions that any business can utilize to improve and increase cash flow. Judson described them as:
Increase sales price
Increase sales volume
Decrease cost of sales or services
Reduce overheads
Decrease debtor days
Decrease stock or work in progress days
Increase creditor days
“The first four levers are focused on the chosen model or structure of the business,” Judson said. “The last three levers detail the efficiency of that chosen business model.”
Each of these levers can optimize cash flow in its own way, and businesses don’t have to pull all of them at the same time. Leaders should first get a read on their current financial position and performance. Then they can determine which lever, or combination of levers, they need to utilize for the desired cash flow improvement.
“The starting point is always the business model and cash conversion cycle,” Sell said. “The executive team has to take a critical look at the most relevant questions.”
For example:
What are the payment terms of my customers, and is prepayment possible?
How long are the payment terms of my suppliers?
Which legal payments need to be taken into account (social security, value-added tax, etc.)?
How do we ensure our receivables remain valuable for as long as possible?
What liquidity peaks occur during the month?
“From there, we create an adapted cash-flow plan and generate a view into the future,” Sell said. “We develop and calculate different scenarios that can help drive the right decisions and generate a little more security before action is taken. By understanding the effect of each lever, our clients acquire a profound knowledge of their capital flow and financing power.”
Even when pulling these levers, however, leaders need to practice caution to ensure they don’t dig themselves into an even deeper hole. On this point, Judson identified three potential pitfall areas that can produce the wrong results:
Altering the levers to create a short-term cash flow deficiency with the hope of a longer-term benefit. For example: purchasing an expensive item/tool/machine with the goal of reducing ongoing labor costs down the road. While this idea has potential benefit, it can hurt you during the short term if you’re not prepared.
Underinvestment in the accounting functions. Judson says that many owners believe that the necessary data to make cash flow decisions should be available instantly. However, their financial systems are not capable of providing such data in real time due to underinvestment.
Lack of communication and confidence. Whether you’re dealing with customers or vendors, you have to be willing to make some hard decisions and follow through. Communicate clearly and be confident in your choices.
1. Cash flow problems often come down to a lack of focus. Coaches have to help leaders stay focused on this issue and hold them accountable.
2. Don’t try to pull every lever at once. Get a grip on the businesses financials and help the leadership make the best decisions for their specific situation.
3. Be careful about creating short-term cash deficiencies with the hope of a long term benefit.
4. Leaders should invest in their accounting functions and ensure they’re getting the necessary data in real time.
5. Communicate clearly and be confident in your decisions, especially when reworking terms with clients and/or vendors.