Avoid a cash flow crunch with these tips and tools
Australian small businesses are owed $26 billion at any one time due to unpaid invoices.
According to software provider Intuit, 60 per cent of small businesses agree that late payments are ‘standard practice amongst their customers, and that they spend an average of 12 days a year chasing unpaid invoices.
That means that there is a good chance that many otherwise healthy businesses are ‘growing broke.’
“It’s possible for profitable businesses to trade their way to insolvency, simply because they struggle to convert invoices into cash,” explains Eli Glotzer, Financial Services Head with Macquarie Business Banking. “Without cash, you can’t pay your staff or your rent.”
Whether you are pursuing an aggressive organic strategy, or seeking merger and acquisition opportunities, cash is the oxygen that you need to fuel your business growth. But if unpaid invoices are pushing the key business metric of ‘average debtor days’ higher, you are effectively lending your customers money interest-free.
It’s possible for profitable businesses to trade their way to insolvency.
According to Glotzer, locking up your working capital by financing your customers’ unpaid invoices can mean lost opportunities and potentially the expense of overdraft interest to your business.
“Every day can make a difference to your working capital,” Glotzer says, “for example a business with annual revenue of $500,000 and average debtor days of 90 days can add over $40,000 to working capital just by reducing debtor days to 60.”
Benchmarking against similar businesses can also help you check whether you are on the right track. Overall 94 per cent of invoice payments will be made within 60 days, and the average payment is made in 44 days.
So how can you get paid faster?
1. Re-set the rules of engagement
If you confidently establish your terms before starting work, you’re far less likely to experience payment delays later due to an unexpected bill shock.
Firms that don’t renew their engagement letters experience more fee pressure, more invoice disputes and longer payment cycles.
“For professional service firms, best practice is an annual engagement letter for ongoing work or regular clients,” says Glotzer. “In our experience, firms that don’t renew their engagement letters experience more fee pressure, more invoice disputes and longer payment cycles.”
Your terms of engagement should include payment terms and late fees for overdue invoices. You may also want to offer discounts for pre-payment or early payment, and transparent processes for debt resolution. Think about what’s standard in your industry, what your clients would be prepared to tolerate – and what might be considered a value-add for them.
2. Keep the workflow moving faster
Glotzer says that while most professional services firms experience cash flow cycles of around 60 to 90 days, other types of businesses like law firms may wait up to 200 days while decisions are pending and responsibility for costs are determined.
“Legal fees can be structured for greater profitability with a higher percentage of the judgment payout, rather than a set fee. But this places considerable pressure on cash flow,” he explains.
No matter what type of business you operate, if you’re struggling to collect payment as soon as the work is done it might be time to re-think the process.
“For example, accountants are now using cloud-based document management systems to help them share files with clients instantaneously and keep accounts moving without delays,” says Glotzer.
The sooner the work is finished and you send the invoice, the sooner you’ll be paid. If you need to wait for project milestones or multiple stakeholder approvals, consider sending progress invoices.
3. Ask for upfront payments
Other options include asking for a deposit upfront, or offering to smooth out a large annual bill with monthly payments.
“Some legal firms charge 20 to 30 per cent upfront. Even if this is locked away in a trust account, it can be immediately released at completion so you won’t then have to wait another 90 days for payment,” says Glotzer.
Accounting firms have started estimating the value of their annual work, and then splitting that into monthly ‘retainer’ payments. “If you do this, make sure you set up an automated payment system, such as a direct debit, or you’ll just have more invoices to chase,” advises Glotzer.
4. Use online tools to track your cash flow in real time
Accounting systems give you a real-time view of your current bank balance and let you print off last year’s Profit & Loss (P&L) report in one click. But what about the future?
This is where the cash flow forecast comes in. It allows you to predict invoice receipts, outgoings and a monthly cash balance for the next year.
Calculating this on an Excel spreadsheet can be prone to error (not to mention extremely tedious). So it’s worth looking into one of the new add-on tools like Float, Spotlight, Crunchboards or Fathom.
These add-ons integrate with accounting systems like Xero and Quickbooks, so they extract the data you already have to update your forecasts in real time.
This means cash flow forecasting is no longer an annual or ‘when I get around to it’ task.
“You want to be looking at cash flow in real time, but spending next to no time doing it. Click a button, and look at your position. It should be that easy,” says Glotzer.
With a cash flow forecast you can quickly visualise your natural cash flow cycle. If you spot a cash crunch ahead, what levers can you pull to convert those unpaid invoices into cash?
5. Outsource funding or collection
“You can offer funding to clients as an alternative payment option,” explains Glotzer. “The funding provider will pay your invoice straight away, and then they receive regular repayments from your client. But be aware that if your client defaults, the risk is with you.”
If your aged debtors are non-responsive or won’t agree on a payment remedy, you may have no choice but to outsource the debt collection. “This is easy to do, and you’re likely to see at least some of the receivables returned, but you probably won’t have a relationship with that client in the future,” Glotzer says.
Time spent chasing invoices, write offs and overdraft interest are all avoidable costs for your business. And if you can get paid just a few days or week sooner by more clients, you’ll have more working capital available to invest in growth.