Cash Is King, Again

It was the type of call that makes company executives cringe.

In June 2008, as the global economy was in meltdown, cash flow at Earth Images, Inc., slowed to a glacial pace. The Greenwood, Indiana, erosion control subcontractor had acquired another firm only to learn the business it bought was inefficient and its equipment old. Not long after, state money from Indiana and Kentucky for the kind of large-scale landscaping projects the company worked on dried up.

That’s when Earth Images President and founder Laura Yurs took the call from her long-time banker.

He phoned because he’d noticed the company was edging up to the limit of its line of credit, Yurs recalls. “I had never gotten a call like that before. He didn’t need to say any more.”

Earth Images had been relying on its bank line of credit to pay bills while waiting for customers to pay theirs. But when the financial crisis hit, the safety net that credit line represented started to disappear for the company and other mid-size enterprises like it.

With credit lines at risk and the recession hammering sales, financial executives such as Yurs faced the challenge of their careers: keeping their companies afloat as cash, the lifeblood of any business, dwindled.

Cash management took a back seat to credit-driven expansion during the economy’s boom years. But with bank credit still tight, companies are refocusing on managing cash to return to a positive cash flow. To get there, they’re reducing inventories, improving credit and collections and motivating employees by linking cash performance to pay.

Even so, mid-size companies are less optimistic than large ones that their working capital situation will improve this year. In a 2009 KPMG survey of 350 CFOs at companies of all sizes in the United States, the United Kingdom and Europe, only 37 percent of smaller companies predicted a rosier future, compared with 53 percent of large companies.

Part of the reason could be the deleterious affect large companies’ own money woes are having on mid-size ones. In the past year, working capital in the 1,000 largest U.S. public companies deteriorated 8 percent, according to REL Consultancy, a division of the Hackett Group. Large companies increased their own collections 10 percent in 2009 but took more than 11 percent longer to pay suppliers, exacerbating cash-flow issues for those businesses, many of which are small and mid-size companies. “The law of the jungle applies here,” says Mark Tennant, president of REL.

From Cash Crunch to Cash Cushion
After her banker’s call, Yurs realized she needed help. For it she turned to the Butler Business Accelerator, a consulting firm run by Butler University’s College of Business. Chris Stump, BBA’s CFO services project manager, reviewed several years of Earth Images financial statements and gave Yurs the bottom line: the company had serious cash-flow problems. If she wanted to save her 14-year-old business, she needed to make changes immediately.

“I didn’t sleep much that night,” Yurs recalls.

Stump immediately instructed Earth Images’ staff to compile weekly cash flow statements. He started regularly monitoring those as well as receivables, inventory and payables, all indicators of future cash flow. Yurs began holding monthly finance meetings with her management team, which Stump attended. She also cut costs, overhauling the company’s back office and cutting duplicate jobs.

To realize income more quickly, Yurs made a concerted effort to get customers to pay bills faster. Accounts receivable personnel began sending invoices weekly instead of monthly. When bills weren’t paid on time, they immediately made follow up calls. The company also stopped its former practice of paying its own bills early, making sure suppliers understood why.

The measures paid off. Earth Images ended 2009 with positive cash flow and is on target to complete $10 million worth of work in 2010. “They are a poster child for effective cash management,” Stump says. “She changed the way her company managed cash in a three- to six-month period.”

Steps to Improve Cash Management
Other mid-size companies are taking similar steps. Forty-eight percent of small companies in KMPG’s CFO survey instituted programs to improve cash management. “The stumbling block is that a lot of organizations have a hard time getting their arms around cash management and understanding it operationally,” says John Cummings, a KPMG Advisory Services principal who advises companies on cash management strategies. “They’re so used to a profit-and-loss statement world and do not understand the implications of cash flow operations.”

Boosting a company’s cash position over the long term takes an organization-wide commitment to change. It also means tracking cash-oriented metrics such as the average number of days it takes to convert inventory to sales or to collect payments, Cummings says. Companies that are most successful at managing cash get executive backing for their initiatives and some even set up steering committees to drive them.

Here are other steps mid-size companies can take to get a better handle on cash:

Improve inventory management – Improving inventory turns, the time it takes inventory to be sold, is an important step toward shoring up cash, Cummings says. To reduce inventory, some companies are slowing production. Others are moving to just-in-time or build-to-order systems, buying or producing goods closer to the time they’re needed. “If you’ve brought in too much inventory or manufactured too much on your shelves, you may have to discount products and that’s a position you don’t want to be in,” Cummings says. “You want to run a tighter supply chain that more closely matches demand to supply.”

Manage receivables more effectively – In the KPMG study, 47 percent of CFOs were concerned slow-paying customers were putting undue pressure on their working capital. In addition, 55 percent expected bad debts to increase in the next two years. To minimize such exposures, some companies are becoming more selective about who they extend credit to. Others have moved payment due dates to 45 days from 60, bill weekly instead of monthly or offer discounts for early payments. Still others have adopted a tiered payment structure, for example, offering 5 percent discounts to customers who pay within 10 days, Cummings says. Some companies instruct their collections staff to call customers on the date payments are due instead of waiting until they’re past due. “It’s the squeaky wheel syndrome,” says Stump, the Butler Business Accelerator executive.

Adjust vendor payments – There’s a fine line between waiting until the day they’re due to pay bills and knowingly paying late. Intentionally make late payments, and suppliers may cut off needed shipments. Cash strapped companies could also ask vendors to sell to them on consignment, basically owning inventory until it’s sold, Cummings says.

Reward managers for meeting cash objectives – If a company’s after better cash management, that goal has to be communicated from the CEO on down, says Tennant, the REL president. Managers need to be accountable for achieving cash management goals, and not just in the finance department. One way to accomplish that is by tying compensation to cash performance. Tennant suggests paying sales reps 50 percent of their commissions when customers place their orders and the rest when they pay their bills. Purchasing managers should also be incented to negotiate lengthier payment terms with suppliers to help the company achieve its cash objectives, he says.

Companies that have been through a cash crisis learn lessons that stick after hard times subside. According to Yurs, Earth Images has continued improving its cash flow as business has picked up. “We’ve changed the whole culture of the company,” she says. “You can throw all the work on the books you want, but if you’re not profitable and if you don’t have good cash management, you’re not going to be in business for long.”