Reference no: EM132223813
The founder of a small consulting firm recently received a letter from an important Fortune 500 client that the large company would extend its payment terms from 90 days to 120 days, “a fancy legalese version of ‘we’re going to start paying you later because it’s better for us; get used to it,’” she says. While she waits four months for payment, this entrepreneur must meet the payroll for her 20 employees; pay rent, utilities, insurance, and a host of other operating expenses; and purchase new computers and other technology to support the work her staff does for clients. Managing cash flow for her business has become more complex, a situation that many small business owners are facing as large companies stretch their accounts payable and speed up collections of their own accounts receivable.
Drew Davies started M&J Kitchens, a custom cabinet seller, in 1985 and weathered several recessions, some of which caused sales to decline by more than 50 percent. Davies thought that his company had turned the corner in the last economic slowdown because sales were running 42 percent ahead of the previous year. Then, M&J Kitchens’s customers began stretching their payments from 30 days to 60 days and eventually 90 days. At the same time, the cabinetmakers who supplied his inventory began requiring deposits on all orders and decreased the credit terms they offered. That combination squeezed the company’s cash flow by $60,000 to $120,000 per month. The final blow came when Davies’s bank pulled the plug on the M&J Kitchens’s line of credit even though he was current on all loan payments. The bank said that the company’s asset base had dropped below the level required in one of the loan’s covenants. M&J Kitchens, which once generated annual sales of $4 million and employed 12 people, could not pay its bills and closed its doors. “We were getting squeezed from both sides,” says Davies.
Laura Yurs, founder of Earth Images, Inc., an erosion control contractor in Greenwood, Indiana, knew that cash flow was tight. Revenue from state building projects, a significant source of her company’s revenue, had all but dried up. In addition, customers for whom the company worked were taking longer to pay their bills. Then came the call from her banker, who had noticed that Earth Images was gradually pushing up to the limit of its line of credit. “I’ve never gotten a call like that before,” says Yurs. “He didn’t need to say anything more.” Yurs had been relying on the line of credit to pay bills because its cash flow was caught in a squeeze.
Yurs knew that if the bank withdrew her line of credit, her business would not be able to survive. She called on Chris Stump, a project manager at Butler University’s Butler Business Accelerator, for help. After Stump reviewed several years of Earth Images’s financial data, he met with Yurs and told her that her 14-year-old company had serious cash flow problems. If she wanted to save it, she would have to make some significant changes—and quickly.
Every week, Yurs and her staff compiled cash flow statements; prepared reports on the company’s accounts receivable, accounts payable, and inventory; and used them to create cash flow forecasts. She also began holding monthly financial meetings with Stump and her management team. She and her staff worked to reduce costs, revamp the company’s back office, and make the entire company more efficient. Yurs began focusing on collecting cash more quickly. The accounts-receivable department began sending customers invoices weekly rather than monthly, and when an invoice slipped past the due date, someone made an immediate follow-up telephone call. Yurs also stopped paying invoices from her vendors early and began sending the checks so that they arrived on the invoice due date.
The changes worked. Earth Images ended the year with positive cash flow, and sales are climbing once again, on track to hit $10 million. “They are the poster child for effective cash management,” says Stump proudly of Yurs and her employees. “She changed the way her company managed cash in a three-to six-month period.”
1. How typical are the cash flow problems that these three companies face? Explain.
2. What advice can you offer business owners about managing their cash flow? (Scarborough 462-463) Scarborough, Norman M. Essentials of Entrepreneurship and Small Business Management, 7th Edition. Pearson Learning Solutions, 01/2013. VitalBook file.