By George Cloutier
Editor's note: This is the eighth in a series of case studies about business turnarounds. The name and identifying details of the company used as the example have been changed.
Problem: Too Much Cash Is Flowing the Wrong Way
Wendy and her husband Ted own a gourmet potato chip factory in Oregon that's been seeing some steady growth in sales over the past few years. Their company, which we'll call "Artisanal Crunch," insists on only using organic ingredients to season their hand-cut potatoes, and this approach has made the brand popular with major retailers of so-called natural snack foods, as well as dozens of high-end grocers on the West Coast.
Today, the company has close to $10 million in sales. But it has no cash. Overheads are gobbling up any profits they make. It's getting to the point where Wendy and Ted are worried they won't make payroll for their staff of 10 workers. The couple have foregone their own salaries and mortgaged their own home to bring in enough cash to operate the business. They have, in effect, become slaves to their business. It makes no sense when they are not even losing major customers. Far from it. Demand for their products continues to be high, despite the recession.
As it turns out, this well-meaning couple delegates their day-to-day bookkeeping to a friend of the family, an elderly lady looking to earn some extra income after her retirement (I've already told you what I think of hiring family in a previous column, and that goes for their friends, too).
When we drilled down into her files, we realized the ratio of receivables to payables is way off kilter. Bills to vendors are getting paid at three times the rate that money owed to Artisanal is getting collected. Receivables are paid as soon as they come in, but payment on outgoing invoices isn't getting collected for months. One large organic foods chain owes six figures on an order it placed six months ago. No wonder this business is operating at a huge deficit!
Solution: Never Pay Your Vendors On Time
Managing your company's cash flow is daily, hand-to-hand combat, and Wendy and Ted need to fight hand and tooth to maintain liquidity. It's not good enough just to collect the cash they are owed. They also need to hang on to whatever cash they do have for as long as they can possibly get away with not paying their vendors.
This idea that you have to pay your bills on time is a mindset among business owners that's all too common. If you communicate honestly with your vendors and explain to them that you have a cash flow problem and need to stretch out payments 60 or even 90 days, they may kick and scream, but ultimately they will accept the terms. No one wants to lose a customer in this economy, and ultimately vendors would rather know they are going to get paid at some point than not at all if your business goes into bankruptcy.
Wendy is balking at the idea because she is under the false impression that paying on time will help her maintain a good credit rating. She also wants to keep her good relationship with vendors. But this has nothing to do with her credit score. Her financials will be in far worse shape if she maxes out her line of credit at the bank or she can't cover her taxes because she used up all her cash to pay vendors. And who cares if she doesn't get a Christmas card from her peanut oil supplier this year? There's no such thing as a favorite customer. Your vendors won't bail you out if your business fails. Same goes for your landlord. Pay him late, too. He'll scream his mortgage is due, but that's not your problem. He won't evict you because he needs the rental income, especially in these times. Send him a check at the end of the month, not the beginning. He'll soon get used to it.
Over the years, my turnaround firm has found millions of dollars in extra cash for companies by delaying payments this way. In good times and bad, it's simply good business practice to stretch out payables. If you have $500,000 in cash expenses and you can find a way to delay paying these bills by 30 days you are, in effect, giving yourself a permanent, interest-free loan. All the big retail chains do it, so why shouldn't you? You are not in business to pay your vendors. Use them and abuse them as much as you can, legally, to maintain cash flow.
Wendy and Ted need to take control of their finances and either get on the phone themselves, or stand over their bookkeeper's shoulder while she negotiates new payment terms and follows up on unpaid invoices. They need to stop being so nice. Once they focus on the numbers and track what is coming in and out of their business checking account daily and weekly, they'll find they have a nice soft cushion to pay themselves a living wage and keep the business running. Because healthy sales are meaningless when you don't have two dimes to rub together.
—with Samantha MarshallCloutier is the founder and CEO of American Management Services, a management firm that specializes in financial turnarounds and profit development for small and midsize businesses. He is the author of the tough-love business advice book Profits Aren't Everything, They're the Only Thing, published in hardcover by HarperBusiness. The book is now a New York Times and Wall Street Journal bestseller.