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How will I meet this week’s payroll?

July 1, 2011
It’s Wednesday and the bookkeeper tells us that we have insufficient funds to meet this week’s payroll. Sound familiar? It’s a common situation faced by many HVAC/plumbing contractors and business owners that we have interviewed, and it really exposes a more generic problem — cash flow management.

It's Wednesday and the bookkeeper tells us that we have insufficient funds to meet this week's payroll. Sound familiar? It's a common situation faced by many HVAC/plumbing contractors and business owners that we have interviewed, and it really exposes a more generic problem — cash flow management.

Cash flow management refers to how we financially manage our business, so that sales and collections are sufficient to meet overhead and operating expenses. It's basic to running a business and indeed many business owners have told us, "I've been doing this for a number of years and I know how to manage my business." Impressive, yet these same people are stressed each week to meet their company's financial obligations. According to Einstein, the definition of insanity is doing the same thing over and over again and expecting different results. How many of us would be judged to be mentally ill by this criterion?

A wise contractor understands that he must be prepared to adapt in order to reduce stress and increase his company's bottom line. Most people acquire their education in a field within five years of entering it and then apply this knowledge for the rest of their professional career. Part of the reason for publishing this article is to motivate contractors to question their normal business practices and to become more receptive to change.

Inadequate cash flow is a major reason why many businesses fail. A profitable company can run out of cash and be unable to continue to operate. While some contractors have taken finance courses and almost everyone acknowledges the importance of cash flow, many do not pro-actively develop a system to manage the company's lifeline, working capital. Some contractors recognize that collections are critical to their business and spend a major portion of their time collecting money and speaking with vendors. While this method may work, it is not an efficient use of time. We have developed a system that effectively addresses this problem in a cost effective manner.

Additionally, especially in today's tight credit markets and the restrictive lending criteria of many banks, it is important to have a good working relationship with your banker. A cash flow projection will show him that you are on top of your business and aware of his concerns; why do you need the money and when will you pay it back? Bankers do not like surprises and will be more receptive to help solve a short term credit crunch, if it is predicted in advance and they have time to do their due diligence. Approaching a banker with a cash flow problem when the need is critical, will give him the impression that you are desperate and not an astute operator.

Perhaps equally significant, banks are looking for ways to earn additional revenues and are less cooperative when faced with overdraw situations. While in the past we could rely on our banker to waive fees for overdraws, it has become commonplace for banks to refuse to waive these fees. We have worked with HVAC contractors who did not realize that they were paying significant bank fees to cover overdraws and other fees. It's foolish to pay the bank to basically help you manage your cash flow when you can do this job better and at a significantly lower cost.

Our system utilizes a basic cash flow statement to predict expected revenues and expenses over a rolling four-week period to manage working capital, which is tailored to a specific company's operation. A four-week period has been chosen as we feel that it is difficult to rely on the results for a longer period. By analyzing cash flow every week for the next four weeks, we are constantly revising our forecast, or rolling the analysis through the year.

Our analysis begins by reviewing A/R and identifying which accounts and which invoices we expect will be paid over the next four weeks, giving us expected cash we can work with over this period. While our normal terms are net 30 and our average collection period is 65 days, we know that Customer A will pay in 30 days and Customer B will pay in 45 days and factor this into our process. Next, we list and subtract all of the operating expenses we will have (payroll, insurance, union dues, utilities, rent, etc.) from the expected cash to provide available cash for vendors. Subsequently, we review the account for each vendor on our A/P list and identify who we expect to pay. Here again, this is done on an invoice and account basis. Combining all of this analysis, we analyze our expected cash position for the end of each of the next four weeks. An indication of a cash short position enables us to proactively plan to more aggressively pursue collections and/or to notify vendors that payments may be delayed.

Using this system, you can efficiently and proactively manage your cash flow issues. How many of us have had to respond to vendors asking when can they expect to see a payment from us? While everyone wants to hear that they will be paid by this Friday, they will be more cooperative if we are honest and give them a realistic date that we expect to pay them.

Personally, I have always felt that vendors were my partners and that I should treat them with respect, acknowledging that they were owed money and that their cooperation was appreciated. We must appreciate that our vendors are also managing their own cash flow and forced to make the same calls and pursue collections as aggressively as we do. Ignoring them, promising a payment we know we can’t provide, or worse yet, giving a check that is backed with insufficient funds will severely damage relations with vendors.

While we all like to pay our bills in a timely fashion, the reality is that we can only pay our bills as we receive cash and some vendors are more critical to our operation then others. Our unique system allows you to estimate collections on the basis of individual clients and to schedule payments for individual vendors and invoices. The major output of the report is your anticipated checkbook balance at the end of each week. With this information, you can appreciate your anticipated cash position, enabling you to pursue collections from specific clients more aggressively and maintain better vendor relations.

Angelo A. Ferrara is the principal shareholder and President of Rapt Enterprises Inc. a middle market intermediary firm involved in business brokering, business coaching and commercial finance. Prior to opening Rapt, Angelo owned and operated a manufacturing company which built customized HVAC equipment for government, aerospace and industrial applications.

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