Cliff was the majority owner of a successful group of five physical therapy clinics. They were growing well, and he and his partners were about to open up their sixth location.
But he was struggling with one important challenge -- cash flow.
When I talked with him Cliff asked, "Why is our cash flow so tight if we're growing so well? I mean, our therapists are booked out, utilization is high, but cash flow is still really tight."
The answer lay on his balance sheet -- he had over half a million dollars in outstanding receivables, mostly from insurance companies. One of the most important lessons with respect to managing cash flow is this: The faster you collect from your customers, the easier it will be to manage your cash flow.
Most businesses carelessly fall into cash crunches because they let their receivables slip longer and longer before being paid. Cliff isn't alone on this, I've seen this hurt professional service firms, manufacturers, and service businesses alike. But the longer you let your receivables slip, the more damaging this can be to your company's cash flow. It not only puts your uncollected revenue in jeopardy and actually lowers your odds of collecting these outstanding receivables, but also the longer it takes to collect on what you're owed, the higher your collection costs, which cuts into your profit margins.
What's the solution? To speed up your "collection cycle".
Your collection cycle is the average time it takes from the moment you have cash going out the door for "cost of goods sold" to the time you collect on the sale of that product or service. And it is one of the most important metrics to track in your company if cash flow is tight or you are going through a period of rapid growth.
For a manufacturer your collection cycle starts when you buy raw materials to produce your goods and continues until the time, commonly three to four months later, when they collect from your distributors and other wholesale customers who buy your goods. As you can imagine, this ties up a tremendous amount of cash which could otherwise be used to operate and grow the business.
For a service businesses your collection cycle starts when you have staff time working on a project. In a service business your "cost of goods sold" would likely include direct labor costs and any materials costs you need to produce your service offering. Your collection cycle ends only when the customer actually pays you for the service.
Far too many service providers make a sale, perform the work, and only then invoice for payment, often waiting 30 to 90 days to be paid after the work has been completed. In many cases, this means that the service business has had the cost of goods sold from labor, materials, and other out-of-pocket expenses to fulfill on its service offering for 60 to 90 days or longer.
Remember, the longer your collections cycle, the more operating capital you need to run your business, and the slower you'll be able to grow without outside capital to fund that growth. Your goal must be to shorten your company's collections cycle as best you can which will free up operating capital to grow your business.
Now that you see how important your collections cycle is to your growing company, here are six tips to speed up your collections cycle and collect more of what you are owed -- faster.
1. Get paid in advance! The best way to reduce your collections cycle is to get paid up front. Getting paid before you fulfill your product or service helps you eliminate the hassle and additional cost chasing down payment later. At the very least, collect a deposit, retainer, or advance.
2. Incentivize customers to pay in advance (if appropriate). You could offer a discount on advance payment, moving the customer to the front of the delivery line, or adding a bonus to their purchase they wouldn't otherwise get. More customers are willing to pay in advance than you might think if you offer them an appealing incentive. Many business owners just assume customers will say no, so they don't even ask. Don't answer for your customers -- ask them.
3. Don't wait to bill; collect right at time of service or delivery. Ask for payment upon completion of the work or at the time you deliver the product to your customer. At the very least, give your customers a bill at the time the services are rendered as opposed to waiting several weeks.
4. Build a "cost" for your clients into your standard contracts. If you are financing your client's purchases, then you should get paid for your trouble. Make sure your contract includes a monthly financing charge for all accruing bills. This clause should also state that the client is responsible for all reasonable costs of collection.
5. Accelerate your production and delivery cycle. Assuming your business gets paid in part or entirely after you have produced and delivered your product or service, then the faster you finish that production and delivery cycle, the sooner you'll get paid.
6. Make it easy for your clients to pay. Accept credit cards, PayPal, and other online payment options. Set clients up on auto-pay through an ACH bank draft or credit card. Take payments by phone or through your Web site. Make sure your invoice clearly says to whom they should make the check out and for how much. Include a self-addressed envelope with your invoice. The easier and more convenient you make it to pay, you the faster you'll get your money.
The bottom line is that by measuring your collection cycle and keeping it visible, you'll be empowered to speed up your collections efforts and have more cash available for growth.