“Cash flow is the lifeblood of every business.” There’s a lot of truth in that simple statement. However, some contractors don’t realize the importance of cash flow management until it’s all too late.
We cannot over-emphasize the role that cash flow management should play in the everyday decisions made by contractors, in order to ensure business operations won’t be halted. Poor cash flow can result in the inability to meet obligations such as payroll or paying suppliers’ invoices, causing costly delays and adversely affecting the reputation of the business. In inflationary environments, the lack of cash flow management will expose weaknesses quickly, resulting in mounting pressure on daily business operations.
When analyzing the most common Cash Flow Killers at any business, there are five main suspects: Failure to negotiate contracts from a cash flow perspective, incorrect timing of cash inflow and outflow, utilization of automatic vendor payments, excessive overhead expenses, and utilizing predatory business loans.
Identify Issues That Hurt Cash Flow
The effects of the failure to negotiate contracts from a cash flow perspective is commonly overlooked. Sometimes contractors are anxious to secure a contract and they do not consider how the terms of the contract can affect their cash flow. Take, for example, the “pay when paid” clause in a contract, which enables the prime contractor the right to wait until they get paid before having to pay a sub-contractor’s invoices. Clearly this clause puts the sub-contractor at the mercy of the prime contractor. The sub-contractor may wait months or even a year after they have performed the contracted job to get paid.
At the heart of cash flow management is the timing of cash inflows and outflows. Incorrectly calculating the timing for customer and vendor payments can be detrimental to a contractor. Negotiating terms with vendors and sub-contractors is advisable to obtain favorable terms for the contractor, particularly while negotiating customer payment terms; it’s important to keep track of the dates when payments are due, and to diligently follow up, in order to accurately manage cash flow.
Automatic payments have been encouraged to avoid late payment fees and maintain good relationships with vendors. However, setting up automatic payments could result in a loss of control over the timing of the payments.
While there are benefits to reducing accounts payable, it is advisable to pay your tier one vendors prior to paying tier two vendors. There are advantages to categorizing vendors by tiers. Create a series of tiers to which you assign vendors. Those who would cause the most disruption to your operation should be assigned to Tier One, and must always be paid first. Other vendors should be assigned to subsequent tiers based on their likelihood to affect operations. This strategy will enable contractors to take better control of their cash flow, and help prevent or minimize issues with daily operations.
Excessive overhead can put negative pressure on cashflow. Setting Key Performance Indicators (KPIs) for operating expenses will set a target for the business expenses. Contractors should constantly monitor changes in expenses to find opportunities to minimize overhead, which will in turn improve cash flow.
In inflationary environments, such as the one we are currently experiencing, being proactive by taking action, such as approaching current vendors for better terms and seeking new vendors with more favorable terms, will help mitigate overwhelming cash obligations.
Do You Really Need Another Loan?
Contractors who have challenges securing conventional loans sometimes become victim to predatory loans with high interest rates and weekly or daily repayment terms. These types of loans can put excessive pressure on contractors to allocate loan repayments immediately and consistently. Many times these lenders require automatic payments from contractors, which subsequently causes them to further lose control of their ability to manage cash flow.
Revitalize Your Cash Flow
A strong cash flow management system can take time to create and implement, but when contractors experience the benefits of accurate cash flow management, they often wish they had implemented an effective system sooner. Speak to an accounting or finance professional to assist with the implementation of a cash flow management system in your business. This is one system that will consistently produce great results.
Founder and CEO of LEK Management Inc., Lynn Karam has two decades of experience in finance, operations, and strategic planning. Karam is an Enrolled Agent authorized by the United States Department of the Treasury to represent clients who are undergoing an audit and to negotiate with the IRS on her clients’ behalf. Her success rate in resolving even the most challenging of IRS scenarios has become the cornerstone of her success. As CEO, Karam uses her financial expertise to establish sustainable strategies that result in significant business growth for her clients.