In the second part of our 4-part series, we are focusing on how to prepare for and withstand a downturn in your business. The strategies below are designed to help you withstand business, industry or economic changes while increasing safety. Our recommendations are focused on proactive measures you can take to prepare your business for the future.
1. Decrease Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO) is the average number of days that it takes a business to get paid after a sale has been made and illustrates the effectiveness of a company’s collections process. Decreasing the amount of time it takes to collect outstanding receivables is a good way to improve cash inflows to your business. It’s calculated by taking your total Accounts Receivable, dividing it by revenue and then multiplying it by the number of days in the period. Common mechanisms to achieve a lower DSO involve increasing the frequency in which your business invoices, instituting late fees in your contract, obtaining upfront payments from customers for services (e.g. deposits) as well as expanding on both the depth and frequency of receivable collection procedures.
Key Takeaway: Review industry business practices and market position to consider whether more frequent invoicing, obtaining deposits from customers or adding late fees and interest to your contracts would be accepted while remaining competitive. It is also advisable to do benchmark analysis to know what a target DSO should be for your industry. Additionally, you can perform a detailed review of your receivable collections procedures to look for opportunities. The procedures might include frequent (automated) reminders in the early stages of collections or direct customer contact while simultaneously problem-solving issues to prevent collections issues once receivables age greater than 30 days. Lastly, once receivables age greater than 60 days, consider withholding further client service to both drive collections and manage any additional risk.
2. Optimize Capital Structure and Increase Debt Capacity
Taking steps to make your business safer is important for preparing to withstand a downturn. A major piece of attaining safety is ensuring the business has cash reserves. To build this up, business owners can add cash to the business by increasing their ownership stake (aka equity infusion) which is a common approach. With this tactic, cash is added to the business without the business taking on the burden of having to repay the amount contributed with interest. Cash can then function as a safety net should a downturn occur. As another means to increase safety, businesses should look to reduce outstanding debt. This existing debt can either be paid down or re-structured. In the case of restructuring, repayment terms can be renegotiated allowing re-payment over an extended period of time or at a lower interest rate. In addition, a line of credit can be expanded allowing additional borrowing capacity as a safety net should a downtown occur.
Key Takeaway: Business ownership should consider a combination of equity infusion as well as debt pay down and/or restructure as a means to meaningfully increase the safety of the business ahead of a downturn. Another option to consider would be reducing distributions out of the company.
3. Increase Days Payable Outstanding (DPO)
Increasing the length of time in which you pay your vendors (aka Days Payables Outstanding or DPO) is another common means to improve a business’ cash flow. This can be achieved in several ways including increasing the number of vendors with which you do business or renegotiating payment terms with existing vendors. Both options focus on the negotiation of favorable terms in a competitive environment to help strengthen the cash position of the business.
Key Takeaway: Review the payment terms of all key vendors and assess opportunities to either renegotiate or competitively bid out key vendor services.
4. Review Your Budgets Often
A budget is a plan for your incoming revenues and outgoing expenses for a specific period of time. It helps you plan, track, and control spending, while also providing a path to support funding requests—from both an operating and capital expenditure standpoint. Small differences between actual and budget figures are normal and expected. If you notice a significant variance in a given period or over time, it signals an area of focus so that you understand why figures are off target and where corrective action should be taken. It will also help highlight and forecast future problems while giving the ability to course correct where needed.
Key Takeaway: Review your budget vs. actuals often. It will help identify key areas of overhead expense leakage to help preserve the bottom line. Also, be sure your budget includes both your capital (Balance Sheet) items and your operating items (Income Statement), so that you have a full picture of your business.
5. Cash is still King so monitor your cash flow statement regularly
The Cash Flow Statement measures how well your company manages its cash position and how well the company generates cash to pay its debt and fund its operating expenses. This report is an integral part of your financial package and ties to both your Balance Sheet and Income Statement. It incorporates how you are using your cash from operating activities (Income Statement), investing activities (Balance Sheet), and financing activities (Balance Sheet).
Key Takeaway: Your Cash Flow Statement should be part of your monthly review and included to bridge the gap between your Income Statement and Balance Sheet. Just as with your budget review, you can also project your cash flows to help make better decisions on where to spend your cash and have a deeper understanding of where your cash is going.
There are many options for building a safer business to prepare you for the future. Additional areas to focus on may include tightening up contracts with existing clients and vendors, increasing business efficiency, thoroughly documenting business processes and tightening those up while also increasing predictability.
Visit this link to read Part III and the rest of our Boom or Bust series.