Beating The Cash Crunch
Ever since taking a $1 million business improvement loan in 1997, Sophie and Roman Shor, owners of Roman Jewelers in Flemington, N.J., had struggled. Sure, the loan let them renovate their store. But it also saddled them with $12,500-a-month payments. The Shors were forced to keep tapping into a line of credit to pay their other bills. "It created a lot of stress," says Sophie, vice-president of the 35-employee, $5 million company. "We were always borrowing from the bank, but it was important that we pay our vendors on time."
After four years of this, the husband-and-wife team finally consulted a financial planner. By improving their accounts receivable and taking control of their debt, they were able to sharply increase their cash flow and get back on track. The Shors have since expanded to a second location, completed the renovations on the original store, and added more profitable, higher-end jewelry lines. "Cash flow is the most important thing in business," says CEO Roman Shor. "Without it, you can't function. But when you have it, you can purchase the most modern technology and get the best employees."
True, the nitty-gritty of tracking cash isn't very exciting. And few entrepreneurs enjoy pestering customers to pay their bills. But falling into the Shors' predicament is no fun, either. That's why it's essential that even those allergic to budgeting learn the basics of managing cash flow.
If you don't already have a system in place to monitor the cash coming in and going out of your business, get started now. The next move is to speed up collections by improving accounts receivable. Then, those who like the ring of the phrase "found money" -- and who doesn't? -- should consider cash flow strategies from managing debt and deferring taxes to making sure your vendors are giving you the most for your buck.
Granted, few people start a business to become bill collectors, and it can be uncomfortable asking customers to pay promptly. The solution is to standardize the process, says Marsha G. LePhew, a CPA and certified financial planner in Rock Hill, S.C. Set up strict guidelines for billing and collection, then make sure your business is using some type of accounting software to track payments. Spell out payment terms on your bill so your customers are aware of your expectations from the first sale. If you don't get paid on time, follow up immediately with a second notice or phone call. "Do what you say you are going to do," says LePhew. "If you slacken on your terms, they'll slacken too." And consider getting cash in the door faster by offering prompt-pay discounts of 1% to 3%.
If possible, make collections the primary responsibility of someone else. Harvey A. Goldstein, CPA and managing partner of Singer Lewak Greenbaum & Goldstein in Los Angeles, suggests hiring someone part-time whose job is solely to collect. That person needs to be sensitive to business relationships and a good negotiator.
If you're having difficulty getting bills paid on your own, you might try using a factor. A factor will give you cash on your invoices in exchange for a 7% to 8% cut or a monthly commission of 0.75% to 2%. Collection is then up to them -- and out of your hands.
Broward Aviation Services of Pompano Beach, Fla., buys and sells commercial airplane parts. So it needs plenty of ready cash to buy before competitors do. That lets it get a better price, too. "If you have cash, the deals come to you," says Timothy Pine, vice-president and partner in the nine-employee, $7.5 million company. When Pine co-founded the company in 1999, cash was tight and banks turned down his requests for credit. Broward sold its receivables to a factor, GE Capital, immediately receiving about 80% of their value and the rest as GE collected from Broward's customers. Then Broward could forge ahead without taking on venture capital. Plus, says Pine, "The banks won't lend to you until you've built up a cash record. Factoring allowed us to stay independent."
Although you want to encourage customers to pay speedily, you'll benefit by paying your own bills slowly. Just make sure you don't miss out on any prompt-pay discounts yourself. Giving up a 1% or 2% discount so you can pay 30 days later is the equivalent of financing those payables at 12% or 24% a year. Ouch.
Paying off debt quickly isn't always the virtue it appears to be. Instead, better to manage your debt by matching the life of the asset being financed with the term of the loan. That can mean spreading a business mortgage over 20 or 30 years if you plan to stay in one location, or taking a 10-year loan on a piece of equipment with a 10-year life span. "Why use up today's cash flow to do something that will benefit the business over a period of years?" says Goldstein. "When you have long-term assets, finance them over the long term." You'll pay more interest over time, but if you use freed-up cash to invest in your company, the trade-off may be worthwhile. You'll also shrink your tax bill, as interest payments are tax deductible in most cases.
The Shors used that strategy to reap serious monthly savings. In addition to their $1 million, 10-year business improvement loan, they had a $2 million, 20-year business property mortgage. Their financial adviser, Al Zdenek of Zdenek Financial Planning in Flemington, N.J., counseled them to focus on the terms of the loan and closing costs when they refinanced. The Shors applied for a combined loan at three different banks, telling each what the others were offering to get a better deal. They landed a $3 million, 25-year loan with an interest rate of 7%, compared with 8% and 9% rates on their previous loans. They even got the bank to cut their closing costs to $35,000, down from the $50,000 to $75,000 typical for a loan of that size. "If you're looking for a sizable loan, you should go to two or three banks," says Sophie. "We were surprised at the various options different banks offered." Their monthly payments fell to $21,000 from $29,100, freeing up nearly $100,000 annually. "The refinancing lifted a lot of stress and allowed us to take the business in the direction we wanted to go," says Roman.
Taxes. Just the word is enough to set off groans. Still, there's plenty you can do to lower today's tax liability, increasing your cash flow. It may be in places you hadn't considered, such as benefit plans. Contributions to qualified retirement plans are tax-deductible -- giving you more cash now -- and the money grows tax-deferred until pulled out at retirement, when you're likely to be in a lower tax bracket. Plus, employees make pretax contributions to the plans, thereby reducing the business' payroll taxes. Since starting a 401(k)/profit sharing plan in January, 2000, Pine and his two partners at Broward Aviation have contributed about $480,000 to their own accounts, deferring about $148,000 in taxes in the process (assuming a 31% tax rate). Broward also saved $17,400 in payroll taxes. "It's found cash," says Pine.
And while defined-benefit plans are going out of vogue at big companies, older entrepreneurs and those who earn substantially more than most of their employees -- the folks allowed to contribute more -- may find them preferable to 401(k)s. Attorneys Mike Norris and Bruce Keplinger, partners at Norris & Keplinger in Overland Park, Kan., changed their company's 401(k) to a so-called safe harbor 401(k) plan in 2001 and added a defined-benefit plan. Both plans let business owners make larger contributions than traditional 401(k) plans in exchange for making contributions to all employee accounts. Norris and Keplinger, who are in their 50s, plowed a combined $215,000 annually into their plans, compared with the $56,000 a year they together contributed to their first 401(k). That let them defer $86,000 in taxes -- more than enough to cover the $25,000 they contributed for the 10 employees of their $2 million company. Two years ago, the partners eliminated the safe harbor 401(k) to cut administrative costs and upped their contributions to the defined-benefit plan. "It reduces our income taxes and allows us to shelter substantially more money than we could with our 401(k) plan," Norris says.
Similar payroll tax savings can result from health insurance plans that require employees to make pretax contributions. With premium-only plans, often called cafeteria plans, employees use pretax dollars to fund an account that helps cover their premiums for the insurance the employer provides. A company whose 50 employees each put in $2,000 could save $15,000 a year, assuming payroll taxes of 15%, says Robert Fox of Suncoast Wealth Management in Tampa.
There's even room to maneuver when it comes to workers' compensation insurance. Generally, businesses make up-front payments to cover workers' comp for the year. Those amounts are based on the business' wage base, job types, and sometimes previous claims. When John E. Kosowski Jr. opened the Birch Street Garage in Cranston, R.I., in 2001, he got quotes for workers' comp insurance of $10,000 to $15,000 a year, including a hefty deposit. "It was insane. That was unaffordable for a business like this," says Kosowski, whose company has revenues of about $300,000 a year. He signed up for a workers' compensation payment service in which payments are based only on actual payroll and paid weekly, so there's no big up-front cost. Kosowski paid about $7,500 for his five employees in 2004. "When you're paying weekly, you don't have to beg, borrow, and steal to come up with an estimated payment and then attempt to reclaim the unused portion. I'd never seen a refund for my business," he says.
The flip side of improving cash flow by bringing in more money is spending less. That doesn't have to mean scrimping. Instead, keep up with frequently changing prices for telecommunications, utilities, benefits plans, and other services. Charges for administering 401(k) plans, for example, have fallen from $50 a person to less than $25 in the past five years, says Anthony Leopizzi, a CFP at American Express Financial Advisors in Harrison, N.Y. "If someone has an old retirement plan, it really needs to be reevaluated," he says.
Daniel J. Friedman, a partner at Wealth Management Group of North America in Farmington, Conn., says his company has changed telecom providers five times in 10 years, saving about $5,000. That may not seem like a lot, but "if you can save 10% to 15% by shopping your services in three or four areas, it really adds up," he says. "And you're not living any differently." Watching your cash flow may not be the best part of being an entrepreneur, but it may be the best thing you can do to help your business succeed.
By Virginia Munger Kahn