This creates a number of problems, especially for service-based businesses where you perform a service, you then bill for that service at some fixed date in the future (for example, the first of the month), you offer payment terms for that invoiced amount (let’s say, “Net 30”) and then, frequently, have to work to collect that amount (which may come back to you in 30-90 days).
In the mean time, your employees expect to be paid every two weeks (along with any vendors you purchased products from for that service or third-party vendors who worked on that service or provided that service).
For example, Joe provides a service on April 1st. You bill for that service on May 1st. You get paid on June 1st (or July 1st or August 15th). In the meantime, you have to pay Joe on April 15th (45 days before you receive cash for that service) and the vendor who provided the supplies that Joe used gets paid on April 30th (at least 30 days before you get paid).
With this kind of cash conversion cycle, it’s hard to grow fast because your cash is always lagging way behind your expenses (in essence, you become a free bank for your clients/customers). However, to grow, you have to have cash. So, what can you do?
Well, there are eight primary cash levers you can pull that you should regularly be adjusting to increase your cash.
What are those eight levers? Well, here they are.
Note: the way I’d use these cash levers is to pull your team together on a regular basis and brainstorm ideas on how to use each lever. For example, “What if we could increase this lever by 5 to 10%, what could we do to get there?”
Lever #1 – Increase the Number of Transactions
If you need cash (and you’re in a business that gets all or some part of cash upfront), you can come up with a number of ideas for how to increase the number of transactions. For example, offering a flash sale to your current and/or past clients/customers. Or creating a more systematic marketing machine. Or creating a more systematic follow-up process for people who didn’t buy the first time, etc. could all increase cash. Note: if your business model is a cash sucking model (like the example above), skip lever #1 or you’ll simply have less cash.
So, assuming you’re not in a cash sucking model, what can you do to increase the number of transactions?
Lever #2 – Increase Your Prices
In general, price is more elastic than most of us tend to think. And the only way to be sure if you’re at the optimal price point is to test your prices until you get enough push back that it decreases your sales and/or profits (noting that sometimes fewer sales at higher price points can dramatically improve profitability and cash).
I remember years ago going to an event for consultants where the speaker promised in his marketing collateral to tell us how to double our prices. At the end of the event, I realized that he hadn’t mentioned his strategy to do that. So I walked up to him and said, “In your marketing for this event, one of your bullet points promised that you’d tell us how to double our rates but you never touched on that over the past two days. So, before I leave, can you share with me your best ideas for how I can do that?” He said, “Sure. Double them.” End of conversation. I went home, doubled my rates and the rest is history.
Note: I’m not suggesting you have to double your prices—that works for some businesses, not for all. The point is that you can probably raise your prices by some percentage point (which is probably higher than you think). Remember, unless you test your prices, you can’t know for sure if you’re at the optimal price point. In addition, if you want to raise your prices, you’ll probably want to add more value or highlight more value in your offering in order to avoid significant pushback from your current customers.
So, what can you do to increase your prices (and then validate those increased prices)?
Lever #3 – Increase the Average Transactional Value
Similar to increasing prices, if you maintain the same number of transactions at the same prices you currently have, you can still increase your cash by increasing the average transactional value. For example, if the average sale for your company is $10K and you do 100 transactions a year for a $1M year, if you can increase the average transactional value from $10K to $12K or $15K or $25K or more, you’ll end up with a whole lot of additional cash.
A few years ago a business owner who heard me talk about this idea went back to his business and challenged his team to increase their average transactional value. Over the course of a year or so, they went from an average transactional value of $25K to $250K. Do you think that helped their cash? Absolutely. As he said, “That one piece of advice radically changed our company and my pocketbook.”
So, what can you do to increase the average transactional value of your customers?
Lever #4 – Increase the Frequency of Repurchase
I’m shocked at how few companies do a good job at helping their current and past customers to buy from them on a more frequent basis—and it often only takes a little extra work. John DiJulius solved this by hiring someone at his hair salon to make sure people coming in for a haircut came back one to two weeks sooner. This doesn’t seem like a big idea at first but if the average person gets their hair cut every six weeks and you can move that average down to five weeks, the number of haircuts per year would move from eight up to ten (or a 25% increase). Even better, if you moved that frequency down to every four weeks, that would mean 13 haircuts per year vs. eight (or a 62.5% increase in top line revenue).
So, what can you do to increase the frequency of repurchase?
Lever #5 – Increase Your AP
Of the eight levers, this is my least favorite. The basic idea is that when cash is tight, you want to think through how you can extend your AP (accounts payable) so you avoid a decrease in cash in the short-term. The reason I’m not a huge fan of this lever is because I don’t like playing games where your success is at the expense of someone else’s cash flow.
However, there are a number of legitimate ways to increase AP without taking advantage of another business owner. For example, your bookkeeper may pay your bills as soon as they arrive, even though the invoice may have generous terms like Net 30 or Net 60. By simply using the full length of those terms, you could dramatically impact your cash flow. Or, you could choose to pay some of your expenses on a credit card in order to play the float, etc.
So, what can you do to increase your AP?
Lever #6 – Decrease Your COGS
Your COGS (cost of good sold) are those expenses directly related to producing/delivering a service/sale. To decrease COGS you could try ideas like signing a long-term contract at a lower fixed price for your supplies. You could automate or outsource certain functions at a lower price point. You could use lower priced sub-contractors or lower salaried employees for that project/sale. You could systematize and then optimize your processes to increase efficiency and decrease waste. You could incentivize your employees to complete projects faster or complete them at a lower price point (and still increase your margins), etc.
So, what can you do to reduce your cost of good sold?
Lever #7 – Decrease Your AR
As a former accounting major, I hate AR (accounts receivable). I hate that float between when you provide a service and when you get paid so I don’t carry AR. In that vein, I’d encourage you to develop that same level of hatred of AR and do everything possible to keep reducing your total AR (the total amount of AR due) and your AR aging (i.e. the average number of days between when a customer is billed and when you receive the money from them).
My guess is that you didn’t start your business in order to be someone else’s bank. So, here are a few ideas you can play with. Instead of billing once a month, you could bill every two weeks (or on the 15th and 30th vs. just the 30th). You could shorten your terms from Net 30 to Due Upon Receipt. You could offer a discount for payment upfront. You could send a reminder email five days before a bill is due, etc.
So, what can you do to decrease your AR?
Lever #8 – Decrease Your Operating Expenses
While COGS influences your gross profit, operating expenses influence your net profits. Your operating expenses are those expenses that aren’t directly related to a specific sale. So, in order to decrease your operating expenses you could negotiate some of your contracts and get a better deal. You could automate some of the work a person is doing. You could outsource some of the work you might be paying someone for today (for ex. moving payroll to a vendor vs. paying someone to come in to do your payroll in person). You could move to a smaller space or a less costly space. You could shift full-time employee work to part-time. You could keep only the inventory your need on hand, etc.
So, what can you do to decrease your operating expenses?
As I mentioned above, every now and then, it’s worth getting your management team together and having a discussion about these eight levers and what you can do to improve your cash. Reviewing these eight levers, which ones can you use and how can you use them?
- Increase the number of transactions
- Increase your prices
- Increase your average transactional value
- Increase the frequency of repurchase
- Increase your AP
- Decrease your COGS
- Decrease your AR
- Decrease your operating expenses
You could also take one of these and make it a quarterly or yearly project. For example, let’s say your AR aging is at 57 days. Why not make it a project this year to get that cut in half (or better)? Set your goal. Come up a plan. Monitor the results you’re getting. And then keep adjusting your tactics throughout the year until you’ve achieved your goal.
Yes, it’s true, growth sucks cash. But when you have a lot of cash in the bank, it certainly solves a whole lot of problems (including sleeplessness).
To your accelerated success!