Using a Collections Model to Understand Cash Inflows

It is a fact that some customers pay quickly, some delay as long as possible and most are somewhere in the middle.  An effective way to determine the period of time over which the total revenue for a given month will be collected is to look at the accounts receivable profile.  Basically, the accounts receivable profile is the standard amount of revenue that is left in the A/R aging at different points in time compared to the amount of revenue originally billed.  Because amounts from several months may become blended over time, you need to make certain judgments about how much revenue is remaining in later aging buckets (60, 90, 120 days) from those prior months. 

Although the average number of days required to collect $1 of revenue can be determined by calculating the DSO (Days of Sales Outstanding—a common accounting ratio), this does not give the whole picture.  DSO is essentially an average, which means that 50% of the cash is collected more quickly and 50% will take more time to collect.  Although this is a good way to see the point in time at which the first half of a specific month’s revenue will be collected, it will not help much to answer the question about the collection rate on either side of that point.  The reality is that revenue is collected over time – there remains less and less of a particular month’s revenue to be collected as time passes, which obviously means there has been more and more of that revenue collected during the specific timeframe.  It can be assumed that all of the revenue is expected to be collected at some point or that a specified percentage will be lost to bad debt or some other adjustment.  It is the rate of collection (by month) between the initial billing date and the day on which the final $1 has been collected that you are looking to identify. 

Once the collection rates are determined, they can be very neatly applied to the revenue for each month and layered onto the collection streams for all other monthly revenues to determine the blended cash receipt estimate for any future month.  This approach has proven very effective for accurately estimating the monthly collection amounts over extended periods.

Revenue Mix and Staff Utilization: Do You Know the Relationship?

In many cases companies (managers) believe that because revenue has not changed significantly or the overall production levels are comparable from period to period that the staffing requirements are the same.  When, in fact, the time required to produce or support one type of revenue can be radically different from that required for another.  It is the mix of these underlying activities that determines the staffing needs of the organization.  If you are only looking at the combined values you could be seriously mismanaging what is arguably the largest controllable expense you have.  Given the expense profile in many companies, this would mean that even if you are focused on managing EVERY other aspect perfectly, your management approach could very well be doing more harm than good.

Never, Ever Pay Early?

Normally, your vendors will have terms established for the payment of their invoices presented for the delivery of their respective products or services.  In order to maximize cash flow, you should attempt to extend the payment a minimum of a week or two beyond those established terms.  In most cases it should be possible to delay payments due within 30 days to 45 or even 60 days before any difficulty would develop with the vendor.  Manage the account relationship by managing the expectation for the timing of your payments.  Communication is the key.

Apart from the fact that you are a nice person and may feel a need to make people happy, why would you pay early?  What benefits are being derived?  The harsh reality is that unless there is a clear, compelling reason for making early payments to anyone (cash discounts, pricing discounts, special delivery arrangements), DO NOT do it.  Hold on to your cash as long as you possible can by closely managing accounts payable.  Take as long as you possibly can to pay your company’s bills without incurring late fees or impacting your ability to operate.  Because your vendors provide the items that are crucial to the operation of the business, these relationships should be managed carefully.


Certainly, if sufficient cash is available to meet the other obligations of the organization, take full advantage of all cash discount opportunities.  The relative returns from cash discounts are usually quite significant and are well worth the extra effort required to manage shorter payment timeframes.  For example, assume a vendor offers a 2% cash discount for payments received within 10 days as opposed to the normal 30-day terms (2 10, net 30) and your company’s standard payment cycle would dictate that payment be made in 40 to 45 days.  By making the payment within the discount terms you are losing the use of the funds at least 30 days sooner than would otherwise be the case.  However, the company realizes a 2% return for the use of those funds over the one-month period, the equivalent of a 24% annual return (2% x 12 months).  There are very few investment opportunities that offer such attractive returns with the certainty of a cash discount.  This is obviously one of the clear and compelling reasons for paying early.

For help evaluating the impact of this and other financial decisions on your future profitability, visit The Profit Experts.

The Trap of “Latest and Greatest”

Be careful that you do not get drawn into the “latest and greatest” technology myth.  There is absolutely no need to consume company resources for the sole purpose of having the most current technology unless there is a clear benefit to the operation.  Be diligent in matching purchases to both the current and the anticipated needs based only on the company’s operating plan.  Do not spend one dime that you do not have to – you will need it someday. Ask yourself: What type of technology or level of capacity is required by the specific application for which you are making the purchase?  Not only is it not necessary to purchase a $20,000 server when a $2,000 desktop PC will do the job, it is irresponsible. 

Back to Basics: EBITDA

EBITDA is the acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA represents (basically) the operating cash flow of the company.  It is a good indication of the cash being generated by the company’s operations and is readily apparent in the P&L (as long as there is sufficient detail provided).  Banks and others use this indicator as a barometer of the company’s ability to meet its obligations for loans or future operational requirements.  Management should use EBITDA as an indication of its effectiveness in producing acceptable cash returns on the company’s operating activities.

There are two limitations that reduce the usefulness of EBITDA as a tool for closely managing the company’s operations.  Since EBITDA only provides information related to the P&L, any activity on the balance sheet such as changes in accounts receivable, accounts payable, fixed assets, debt, etc. are not indicated.  Therefore, large swings in cash will be missed if you are only looking at EBITDA as a cash management tool.  Also, as with the Statement of Cash Flows, EBITDA is only available when the P&L is produced making it unusable for managing the daily or weekly business requirements.

Employee Turnover: The Most Misunderstood Expense in Business

The cost of turnover is a major problem.  This could be the most misunderstood and under estimated expense in business.  Depending on the capability to recruit, the length of the standard learning curve for new staff and the actual turnover rate, the numbers can be extremely large.

In addition to the direct cost of hiring and training new staff, the financial impact of lost efficiency and the stress induced on current employees resulting from the recruiting period and training requirements after a new hire is quite significant and it cannot be easily calculated.  The problem is threefold.

1.       The process of recruiting and hiring replacement staff can take weeks or even months to successfully complete.  Until it is finished there is a need for existing staff to provide support in completing the tasks required of the vacant position while at the same time meeting the requirements of their own positions. 

2.       Once the process has been completed, the amount of time it takes the new employee to get through the normal learning curve can also take weeks or months.  During that time there is a tremendous gap in productivity vs. compensation.  Until the new employee is fully trained, there is a serious negative leverage working on the profitability of the company. 

3.       Training new employees has both a direct and an indirect affect on current staff members.  Where time is required of the existing staff to train, it directly reduces the time available for them to respond to normal operating issues.  Also, the need to cover gaps in efficiency caused by the learning curve indirectly affects the performance and morale of other staff.  The existing staff members often find themselves in a position where they are unable to complete their own tasks on time while being required to assist in covering the requirements of the newly staffed position. 

Each time these situations occur, the stress on the organization is significant and, depending on the specific circumstances, can continue for extended periods.  The effects are more severe in smaller organizations where the absence of one individual can have a dramatic impact on the overall staffing and there are not as many other employees to cover the gaps in efficiency.  The issues arising from these situations can have far reaching affects on the entire organization. The message here – serious consideration should be given to staff retention and the relationship to overall payroll costs.

One efficient way of augmenting your financial staff with senior-level expertise is by working with The Profit Experts.

Sources of Financing: The Government

Federal, state and local governments have become progressively more active in business financing in order to facilitate growth in the local tax base, increase employment or accomplish certain other social goals.  There are numerous programs available depending on the size of the company, the location of the business and the ownership profile.  Small Business Administration (SBA) loans, economic development area incentives and specific bonds issues are some examples of this type of financing.  Usually the funds are made available through low cost loans with or without government guaranties or certain specific tax incentives.  Terms vary by program and individual application. 

U.S. Small Business Administration (SBA) loans are probably the best known and most widely accessed of the government programs.  These loans are made by local banks and are guaranteed by the SBA.  The SBA’s guaranty makes it easier for the bank to make loans on terms it would not otherwise be in a position to make available.  There are several types of loans available ranging from $5,000 to $2,000,000 with varying purposes including commercial mortgages, equipment term loans, general purpose term loans, working capital lines of credit and business acquisitions.  Successful applications will include a well developed plan with:

• a narrative on the company background, the principals and the outlook,
• company historical financial information and financial forecast including cash flow with assumptions,
• a use of proceeds and,
• personal financial statements and tax returns for the principals.