Empower your business with proactive processes
Three strategies to help safeguard against economic shocks
If the past two years have taught us anything, it’s to believe in the adage “Expect the unexpected.” Rather than believe, perhaps it’s better to embrace in order to empower your business against situations that otherwise feel uncontrollable.
Economic shocks are inevitable; proactive strategic thinking can help your business withstand and, ideally, survive whatever the future has in store.
Shorten the “Payment to Cash” stretch
While you might not have heard this phrase before, you’ve likely felt the stress of it.
The “payment to cash gap” represents the duration between when you pay for stock or materials and compensate your employees and/or subcontractors to when your customers pay you. The longer this duration stretches, the more tenuous your return on investment (ROI) becomes.
Consider the following strategies:
- Leverage merchant services to collect payment on the job immediately upon work completion.
- Don’t fall behind when it comes to invoices; offer incentives to customers for early payments.
- Request deposits for larger jobs.
Ask the following questions:
Could your vendors offer more flexibility with their payment terms?
You want to decrease the time between receiving payment from customers before paying vendors. If you can’t agree on more favorable terms, forfeit the 2% discount for payments submitted at 10 or 15 days and just pay on a net-30 schedule.
Is it possible to improve your profit margin?
After all, at the end of the day, higher margins equal more cash in your pockets. You can do this by:
- Prioritizing faster selling, higher margin products
- Decrease discounting frequency or reduce discounts on prices
- Shop around — reevaluate and consider renegotiating the costs of vendors and overheads like internet, phone, and healthcare
- Determine where you can reasonably increase your pricing while being mindful of your customer’s tolerance and sensitivity for prices.
- Reduce, reuse, recycle — apply this to your purchases, always.
- Limit your exposure to uncollectible receivables by limiting the amount of credit extended, following up promptly with late payments, and reducing the risk of fraud via services like Positive Pay.
Establish cash flow warning triggers
A warning trigger ideally allows you to compare current performance against past data, whether your company’s or the industry’s.
Set up triggers for the following:
- Collection Period: Track customer payment behavior vs. your own and industry standards; for instance, net 30 days to submit an invoice. Average number of days outstanding is 35? Trigger your debt collections practices by contacting your clients for payment.
- Demand: Changes in leading indicators, such as inbound inquiries from prospects, new opportunities added per month, demos or meetings booked, or inventory turnover can help predict cash shortfalls. Review which of these is relevant to your business and identify ways to protect your bottom line.
- Gross Profit: By tracking your company’s gross profit percentage over time, you can schedule a trigger to alert you if it falls below X% of your targeted budget.
Isolate alternative sources of financing
If you approach your bank for credit, the amount of capital you have in the business will determine whether you’ll be approved for credit, as well as how much. Capital is intended to safeguard your business against economic shocks.
Review your own reserves. Traditional advice suggests a minimum six months of expenses saved in the bank; ideally 12, if possible. These funds will help your business survive against unexpected losses or unfavorable industry shifts.
How much reserve capital does your business actually need?
It all depends on your own cash flow forecast and relevant “what if?” scenarios. If the number exceeds what you currently have available, consider approaching other sources, whether angel investors, Small Business Development Centers, industry grants, or more personal paths closer to home, like taking out a second mortgage or enlisting the help of family and friends.
None of us has a crystal ball; however, you can set up your business to better anticipate and endure moments of financial weakness. Ultimately, you want a short cash cycle with enough cushion to absorb any economic shifts to ensure your business is agile and resilient because, let’s face it, it needs to be.