A manufacturer of scientific and medical equipment experienced negative cash flow for years. They used credit to provide cash, and when credit ran out they hired a cash flow expert. The cash flow expert gave them three pieces of advice:
- Budget: Understand upcoming expenses and compare them to upcoming receivables and future sales.
- Accounts payable: Use electronic funds transfer to make payments on the last day they are due. You will remain current with suppliers while retaining use of your funds as long as possible.
- Sales: increase top line revenue
One year later, their debt was so grave that they closed the business.
Cash flow management is meaningless if you first don’t correct the causes of negative cash flow.
How to Create Positive Cash Flow and Cash Accumulation
There are three tiers to positive cash flow and cash accumulation.
Tier One: What your customers and clients see
Pricing model: The two choices are time and materials or value based pricing. Time and materials forces you to deliver the product or service first and bill after completion. This always causes negative cash flow, because payables are due as the work proceeds. Value based pricing is determined in advance and billed in advance.
Profit: your pricing must include a specific profit margin. No sale should be allowed unless it includes this profit margin.
Terms and conditions. If you charge for time and materials, the details of your terms and conditions may reduce, but not eliminate, negative cash flow. If you offer an incentive for quicker payments, you reduce your cash accumulation. Value based pricing eliminates negative cash flow because payments are due in advance.
Tier Two: Internal processes
Invoicing: Your AR system has to be designed to invoice immediately and apply payments to specific invoices.
Installment or periodic payments: For some long-term value based engagements you may provide installments. Your system has to set these up instantly to invoice for the first payment and subsequent payments. It also has to have a built-in alert when a payment has not been received, so you stop delivering and investigate why the payment has not been received.
Cash flow report: This should be generated daily for decision-makers to allow for interventions at the earliest possibile moment.
Tier Three: Make Cash Flow everyone’s business
Everyone in the company should be taught about cash flow and what it takes to create positive cash flow and cash accumulation.
Sales: have confidence in the pricing model and terms and conditions
Marketing: attract prospects and retain clients who want value, not those who are buying on price
Customer service: extra care makes value pricing feel worth it
Human Resources: cutting expenses is not the solution to increasing cash accumulation.
CFO: financial planning will contribute to company growth and value when positive cash flow and cash accumulation are ensured.
Digital presence: ensure that all digital collateral conveys high value commensurate with the company’s value based pricing.
A visual of our 7 steps is here.
What’s Your Next Step?
If negative cash flow is a current problem, the first step to change your pricing model. You may do this one product or service category at a time, but you must do it.
The second step is revising your terms and conditions. Don’t be like the consultant I knew who accepted 90-day payment terms because he didn’t want clients to think “he needed the money!” You earn the money, so step up and expect it.
If you’re curious about how you could take these steps, remember—long term success is a series of steps, not a one-time action. These are difficult changes to make and lots of emotions can hinder your implementation. Let us know if we can provide support for your Money Matters in any way. 703-801-0345.