“Tom, I know I’m making money because I’m profitable every month. So why do I always struggle to make payroll?
I was asked this question again last week – the answer is usually working capital and cash management. In this case, the answer was simple enough, once we looked at the company’s cash cycle. The company provides IT services and their costs are almost exclusively payroll, which is paid twice per month. Client invoices go out monthly, two weeks after month end. The company’s standard payment terms are net 45 days, but most of their customers are very large companies that pay in 60 days (and sometimes 90), regardless of terms.
Let’s run the math:
So it is at least 2 months, and often 3 or more, before they collect the cash they’ve already spent on payroll. If there is any volatility in sales, a delay in billings, or an increase in AR Days Outstanding, cash problems appear quickly.
What did we do? First, we designed and implemented a Rolling 13 Week Cash Flow Forecast and developed a weekly Flash Cash report so working capital gaps are identified long before they become issues. Second, we assisted in putting a bank Line of Credit in place to support their working capital needs. As a result, the company is better equipped to understand their cash flow cycle and payroll is covered every week.
Cash management is all about knowing when it’s coming in and when it’s going out.