“Why is the checking account always empty? We have solid revenues and exploding sales!”
I’ve heard this from too many startups. As a company scales, it often needs to adjust how it does business. One obvious sign of trouble is a lack of cash. Positive cash flow is crucial to a young company, which means negative cash cycles can slow or even kill a company.
How a cash cycle gets “broken” varies by type of business, but the good news is that it can be fixed. Here are three stories where I’ve helped startups get back on track by improving cash bleed and scalability.
1. A Services Company: Billing Too Little, Too Late
The first client is a technical services company that does contracts that run anywhere from three to nine months. This tech company was sending the first invoice partway into the project, with a big pay at completion. This strategy is pretty common.
The first challenge we saw that contributed to their negative cash problem was that their customers had very little urgency to either complete their project—or pay the final bill.
Their customers gained the information they needed throughout each project, and had 90% of the results they wanted before the final report. So they were in no hurry to make that last big payment. But not receiving that payment on time was strangling this tech company.
To fix the cash flow problem, first we instituted customer deposits. Before work began, they started asking for 40% of the total price of the project to be paid up front. That was a huge shift, going from 70% of the project being paid 30-60 days after completion to 40% paid before it starts. And their customers were fine with that.
Another healthy portion of the bill was then invoiced mid-project. We converted the final bill to about 10-20% of the total cost and attached payment to the delivery of the final report. Their customers needed this clarity. The customer already knew what the final report said before they saw it, but they still needed to have the final version.
By then, our client already had 80% of their cash in hand, and their customer has some skin in the game and motivation to pay the final bill too. This solution was fair and greatly improved their cash flow cycle.
2. A Manufacturing v. Sales Showdown that Stalled Installs
My second client tale shows an interesting approach to fixing an unnecessarily long operating cycle. This company was a large organization suffering from conflicting incentives and dueling departments. Their large direct sales force was incentivized to hit their projections every quarter as well as to forecast aggressive revenues and say “we’re going to crush it.”
They were consistently forecasting and achieving their quarterly objectives, however, in reality, the sales force had developed a reputation of rarely hitting their numbers.
On the other side, the manufacturing and supply chain folks were incentivized to minimize how much inventory the company carried—keeping those costs low. They didn’t want to burden the organization with the cost of unsold product sitting on a shelf.
As the company grew, what started to happen was that Manufacturing was saying, “These sales forecasts must be inaccurate. They’re always over-forecasting and we no longer believe them.” So they reduced their build schedules below the official sales forecasts.
But when sales orders started coming in, manufacturing had to say, “Well, we haven’t built that yet,” or “It’s not on the shelf.” This created a delivery issue to the customer, and the company had to go get the parts or manufacture, test, and ship it to the customer. And then install it. With a delay—not a healthy long-term business practice.
We saw that this growing distrust between the sales and manufacturing/supply chain teams lengthened the company’s order-to-cash cycle because of the misaligned incentives and lack of customer focus. Availability was delaying install.
When a new CEO came on board, he sat down with the heads of both departments, and they hashed out a new mechanism. Manufacturing wouldn’t be penalized if they adhered to the sales schedule. On the Sales side, the company put a little more rigor in the analytics behind their forecasts, because when you looked at those, yeah, they were overly optimistic.
In the end, we created a better build schedule with analytics both sides agreed to. We built new metrics around forecast accuracy in Sales and available-to-promise (ATP) in Supply Chain. We said that if a sales rep sells something, it should get there in two days. To do that, we looked at how orders close and get ready to ship. That helped to schedule the install team and the implementation team more effectively.
So now, as a fast-growing company that had gotten too big for the old way of doing business, they had a much better process that would take them into the future.
That’s a more complicated fix than in the first story, not just a quick billing shift. We had to get two big egos to sit down together and hash out how to make this work. Yet we shortened their cash conversion cycle in a huge way based on this effort.
3. A Poorly Priced Product-Maker Pulled Back from the Brink
The third company wasn’t even sure their business was going to work, honestly. The company was a TV ancillary product manufacturer. They created a plastic doohickey for entertainment systems—the kind of product you find selling in the front of Best Buy. They manufactured their low-cost product in Vietnam.
Right off the bat, one thing we saw was their tight product margins. Secondly, they had to pay out long before they got paid.
They shelled out a third down when they placed the order with the manufacturer, another third when it was put on a boat, and the last third upon clearing US Customs. Then it typically took another two weeks to get ready to ship to their customers.
Those customers were large retailers like Target, Best Buy, and Walmart, who all had net 60 and 90 terms, most 90. Worse, the purchase orders were typically non-binding, so they were hard to finance.
Why would a bank loan you money to manufacture a product if your customer’s order is 100% cancellable? You might bring product all the way to the US only to hear your customer doesn’t want it. Or that the product they ordered last time isn’t selling and they don’t want to place the next order.
This situation created a massive a six- or seven-month negative cash cycle just on the payables to the manufacturers and the receivables from the customer. It required financing. But with a low margin product, financing is expensive.
If you have a 50% margin, the cost of financing alone can have the impact of sucking up about 10 points of gross margin. That’s huge, and it makes the entire profitability of the company and the rest of their operations very challenging.
Because their cash was so hamstrung by the cost of financing, they just couldn’t grow. They couldn’t grow fast because so much cash was tied up.
We helped this client look at the levers to help make their business work. They could:
1) Reduce the cash cycle by manufacturing somewhere else or by renegotiating terms with the manufacturer, or
2) Figure out how to improve core product margins substantially so that the company could afford the financing costs.
Now they could clearly see where their cash problems originated and how to fix it.
Freeing your cash is crucial for growth. I hope looking at these three specific examples of startup growing pains gave you a sense of how you can tighten your company’s negative cash cycles. If you need more help, let me know.