Cash and Cost Management Best Practices Guide

It’s a seemingly contradictory situation, but one lenders run into quite often. “We see lots of companies that have strong cash flow, but their profits are weak,” says Hugh Donlon, Regional Sales Executive at KeyBank. Profitability is important for a company to establish the value of the business, qualify to borrow money, and do proper tax planning, he points out.

Robert E. Mittelstaedt, dean emeritus and professor of management at Arizona State University’s W.P. Carey School of Business, believes the adage “grow or die” is true in business. Growth requires cash to invest in every aspect of the business, but less-experienced business owners are often caught off-guard by a rapid increase in cash needs for receivables. “If you sell more to customers, then you will have more outstanding receivables, unless you are in a pure cash business, and you will have to fund the higher costs of more business, while waiting to collect receivables,” he says.

Identifying tipping points

Creating, regularly updating, and sticking to a strategic cash and cost management plan can help businesses address that and a host of other challenges. A well-prepared plan will show you the tipping points in

your business, says Gregory Wank, chair of the Food & Beverage Services Group at accounting firm Anchin, Block & Anchin. “At what point does accounts receivable or inventory growth absorb too much cash? When is the right time to borrow? When putting together a strategic cash and cost management plan, you need to accurately project your operating cycle, which is the timeline from the moment you order goods until the moment you are paid by your customer for the product or service delivered,” he says.

Getting the most bang for your buck

Optimizing cash flow and minimizing expenses both have the potential to improve a business’s financial performance, but they don’t operate in a vacuum. Developing a strategic cash and cost management plan can integrate the benefits of each and provide the greatest return to your business.

KeyBank client: Jay Davidson, Tri-Med Ambulance

Profitability requires more than cash flow.

“When cash flow is adequate, but profits are anemic or nonexistent, lack of a strategic approach to cash and cost management is often the cause of the problem.” Hugh Donlon

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Creating a planPutting together a strategic cash and cost management plan starts with some self-examination. “Each enterprise needs to determine what is core to its business, and those are the things on which it should focus,” says Maxine Attong, a certified management accountant (CMA) and co-author of Change or Die — The Business Process Improvement Manual (Productivity Press, July 2012). Core areas are usually those that generate the highest levels of income, account for the most resources or expenses, or make the most significant contributions to branding or goodwill. “Any operational area that contributes to each of these three criteria should take the biggest portion of spend,” she says. “The second level of spend should be on areas that directly support these criteria.”

Focus on critical levers

“A business’s critical levers are most important. For a manufacturer or a wholesaler, source of supply is usually a critical lever. How those businesses manage their cost of goods sold is a huge factor in their success,” Donlon explains. Lenders look carefully at a prospective borrower’s gross profit margin, which can be influenced by a variety of factors, such as transportation, delivery, and raw materials costs for manufacturers. “With service businesses, we look at the vendor relationships that are critical to their business and their major recurring overhead items,” he says. “We’re interested in how they are managing their costs and whether they are pricing the services they sell appropriately.”

You need to look at operational areas of your business when formulating a strategic cash and cost management plan, Mittelstaedt says. “Ask yourself where you need to invest to stimulate growth and where you can cut expenses or improve productivity without hurting current sales, quality, or customer service.”

“The choice of which operational areas the plan should focus on is dependent on the type of business, regardless of the outside bookkeeping/accounting support it may have.”

Hugh Donlon

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The tactical nuts and boltsThe tactical foundation for the strategic plan should be a monthly forecast for revenue and all major expense categories, Donlon advises. “You should track those numbers every month and review them at least quarterly, but monthly is better. You don’t want a big surprise halfway through the year, such as finding out your healthcare costs are 10% higher than you budgeted for,” he says. Part of the review process should include a regular look at your vendor relationships to make sure they are fair and equitable. “Make sure you’re not overpaying for the value you receive, especially on high-cost items like insurance. Data is only valuable if you are using it and comparing it against something,” he adds. “When you see a business that has strong cash flow, but is not profitable, it’s usually because they are not going back to their expense forecast and comparing actual numbers to budgeted costs,” he adds.

Seek economies of scale and productivity increases

Strategic cost management tactics should start with productivity increases, Mittelstaedt suggests. Some questions to consider: Can you reduce costs by investing more in IT to reduce staff growth? If you are a manufacturer, can you automate portions of the manufacturing process? Can you outsource some non-core functions to third parties? Take a close look at how your sales force is compensated, with an eye toward making more compensation incentive-based. Establish aggressive, but achievable performance metrics and hold your salespeople accountable to them. When conducting the kinds of reviews Donlon suggests above, make sure you understand whether and why your costs vary from the norms for your industry or sector. Mittelstaedt stresses that, other

than raw materials, none of your costs should show a lineal upward trajectory. “You should always be looking for economies of scale and making sure you achieve them,” he says.

Brainstorm ideas for ways to accelerate your inflow of cash, such as by offering customers early payment discounts, Wank advises. The mirror image of that tactic is looking for ways to slow down the outflow of cash. Consider requesting extended payment terms from vendors, making payroll biweekly instead of weekly, or leasing a new piece of equipment rather than buying it outright.

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Potential stumbling blocksAs Donlon points out, the level of expertise a business owner has access to is an important variable in formulating a strategic cash and cost management plan. For business owners tackling this project mostly on their own, the most trouble-prone areas are those where you are not an expert. “If you know sales, but not technology, you are likely to have more trouble managing IT expenditures than managing the sales force,” Mittelstaedt says. “If you are outside your comfort zone, then make sure you get help from others who know the area — and always seek more than one opinion.”

Having the right partners and support is critically important to the success of this process, Donlon emphasizes. “I encourage any business owner to look for people who are proactive in terms of the ideas they bring and the value they provide. A lender who just provides a loan or an accountant who only does your taxes just doesn’t cut it. When you’re creating a strategic plan for cash and cost management, you want access to professionals who are constantly thinking about your business, coming up with solutions, and working to help you meet your goals,” he says.

Justifying your projections

When considering a business for a loan, lenders typically look for a verifiable track record — a minimum of two or three years of successful operations and the financial records to document it — and a three-year forecast. Projecting that far out into the future can be challenging for many small businesses, but it’s a “very healthy exercise for them to do,” Donlon asserts. Where some growing businesses run into problems is in finding ways to justify their projections. For example, if your financial records show a revenue growth trend of 10% a year and you are predicting a 25% uptick in a coming year, you must be able to back that up with something like a signed contract from a significant new customer.

“Financing rapid growth is one of the most challenging things we do,” Donlon says. “The impact of rapid growth on a business is very, very stressful.” In order to successfully meet that challenge, a business must have several key elements in place, including the right financial management support and key suppliers they know can keep up with their growing demand. “Owners need to make sure they

have the time and resources needed to focus on financial support and operational efficiency,” he says. That means creating a strategic cash and cost management plan, reviewing it regularly, updating it as needed, and acting on what the data tells you.

Priorities and rationalization of cash resources between competing strategic initiatives is a constant challenge in this exercise, Attong says, but communicating the strategic intent to staff may actually be the biggest challenge. “They may perceive changes in cash and cost management strategies as calling the viability of the company or the quality of executive decision making into question, which could raise employment concerns for them,” she says. “Rigorous change management may be needed to allay the concerns of both internal and external stakeholders.”

©2013 KeyCorp. KeyBank is Member FDIC. Equal Housing Lender. All credit products are subject to credit approval.

KeyBank is providing this brief overview to raise awareness concerning the changing economic landscape. The information and recommendations contained herein are compiled from sources deemed reliable, but are not represented to be accurate or complete. In providing this information, neither KeyBank nor its affiliates are acting as your agent, broker, advisor, or fiduciary, or are offering any tax, accounting, or legal advice regarding these instruments or transactions. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Before entering into any financing arrangement, please seek counsel from your own financial, tax, accounting, and legal advisors.

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ConclusionA business’s approach to strategic cash and cost management is likely to vary based on the size and type of the company, its industry sector, and its goals, but some best practices in this area have broad application:

•Strategic management of cash and costs are equally important. Cost cutting or containment alone is never the answer, Mittelstaedt says. “Revenue growth and profitability are the answers, so never confuse cost management with success.”

•Planning is critical. “Make sure you not only have a plan, but that you manage it as well,” Donlon stresses.

•Make the distinction between cash flow and profitability; both are important, but they must be looked at separately.

•Find the right partners — banker, accountant, attorney — and enlist them in this process.

•A strong cash-flow model is a blueprint for your business. “It shows your level of self-sufficiency and where the soft spots are in the capital base,” Wank says. “It will allow you to plan for borrowing and be proactive in addressing weaknesses at various times during the year.

•Factor duration and cultural impact into your planning. “Is this a quick fix or a new direction for the business? What’s it going to mean to the organization, and will your staff be willing to deal with it? Change management is how you deal with these issues,” Attong says.

Differences among various types of businessesManufacturers, wholesalers, retailers, and service businesses all share some common issues as far as the process of creating a strategic cash and cost management plan is concerned, but there are also important differences in the approach each type of business should take. The key element of the process is universal, Mittelstaedt says. “Understand your triggers, the things that will make you look harder at cash and cost management as a strategy. Do your triggers involve reduced margins, decreasing sales, increased costs of materials and supplies, lower sales per employee or sales per square foot, declining or flat earnings, or some other metric?”

For most service businesses, there are fewer variables involved. A service business has to pay its employees and/or outside contractors regularly, and it needs an appropriate amount of capital base to finance the time until its customers

pay for the services rendered, Wank says. A business with inventory, such as a wholesaler or retailer, has more variables to deal with beyond payroll and collection times because it must finance its inventory, as well as receivables, and manufacturing firms have the greatest number of variables among all types of businesses. “Manufacturers have to focus on process efficiency, supply chain, managing raw materials costs, vendor relationships — the list goes on and on,” Donlon says. “With service businesses, human capital is usually the prime consideration, but concentration of too great a percentage of the business with just one or two key customers is also an important consideration.”