​I think we could actually be aiming at a repeat performance of at least some of the financial upsets that occurred in 2007 and 2008.  Here’s why.
 
Home buyers must qualify for mortgage loans.  The higher the price the higher the down payment amount.  The higher the interest rate the harder to qualify.  Remember that every half percent of interest rate increase adds somewhere around $100 to the monthly payment.
 
Today’s 30 year fixed rate is approximately 4.25%  Of course there are a variety of rate programs available but the point is nothing will get cheaper at least in the short run.
 
Lot and material prices are all increasing.  Supply chain delays cause longer build-out times.  Longer build-out times combined with higher land and material prices increase the carrying cost of a construction loan.  In the 2007 – 2008 period many developers and builders saw any equity they had in projects erode and go away.  Loan defaults and bankruptcies followed.
 
Some lenders took large losses or at minimum had to reserve more for loan losses thereby compromising income.
 
Could all that happen again?  You bet it could.
 
What’s different now?
 
On top of increased costs we have an unstable world situation.  Can that have an impact on supply chains?  Certainly.  What about fuel prices?  How much will they affect material cost?  I don’t know exactly but it’s safe to say that increased costs will be passed on from the top to the bottom of the consumption scale.
 
The last time around, at least in our area, there were many of spec houses on the market.  If that happens again we can expect weak financial conditions to repeat themselves.  Also the last time around, house prices dropped very rapidly.  So, on top of equity erosion from high costs, developers and builders sustained more equity erosion from decreased asset values.
 
This article has been aimed mainly at home builders.  BUT, it’s important to recognize that the same fact set also applies to every other branch of the real estate tree.  Right now, the office and retail segments are very soft.
Quite a few people have expressed optimism about the multi-family segment.  I don’t share that enthusiasm.  If we go into a prolonged slump, this segment will join the others that aren’t performing well.
 
If you would like to discuss any of this, please drop me an email at [email protected].

​If someone asked you what the most important thing about selling was for your business, how would you answer?

• Growing my business -

• Delivering quality products and services –

• Increasing profit –

• Making more money for me –

 
Those are good answers and there are probably many more.
 
But, the right answer is collecting the money you’re owed.
 
There are two essential parts of the credit sale process:

• Delivery and acceptance

 

• Billing and collection

 
Of these, delivery and acceptance are the most critical.
 
Suppose you manufacture hats and you get an order for 100 dozen red hats.  You make the hats and to your eyes they look red.  The hats are packaged and shipped.  OK we have the delivery piece in motion.
 
Suppose that somehow shipping labels were confused and the hats that were delivered were blue.  Will the customer want and take the blue hats?  Maybe, maybe not.  If they’re not taken, there’s no acceptance.  So now we have delivery but no acceptance.  And we may not be able to move into the billing and collection part of the process.
 
But let’s presume the red hats were delivered and the customer accepted them.
 
Now we can move on to billing and collection.
 
What is your billing procedure, what are your terms if any, and most important what are your policies and procedures for policing your credit sales?  Do you have policies and procedures for collecting your money?  Many businesses don’t or if they do the policies and procedures are not enforced or enforced halfheartedly.
 
Customers will do what you let them get away with.  Let’s say your terms are net 30 days.  If your customers know that to you net 30 means give it a few more days to see what happens, many of them will take that extra few days.  Guess who gets hurt?
 
Several years ago I wrote an article titled “We’re Selling More than Ever but We’re Broke”.  That article talked a lot about credit and collections policies and procedures.
 
Every business at some point has to decide whether growth is the main objective or profit is the main objective.  The faster a company grows the more likely it is that credit and collections policies and procedures will become lax.
 
It’s your money.  Make sure you are doing everything you can to make your Accounts Receivable good accounts not no accounts.
​

How many times have all of us heard that over the years?  Probably dozens.
 
How many times does that question apply to our businesses?  Probably dozens.
 
We concentrate on product quality.  We concentrate on customer service and customer retention.  We concentrate on profitability.  We concentrate on competition.  We concentrate on marketing.  We concentrate on networking.
 
How often do we concentrate on the customers that make-up of our accounts receivable?  Way too often not enough.  Here’s why.
 
As businesses grow, so do the need for credit sales – accounts receivable.  Many times the growth speed is faster than the keeping up with growth speed.
 
Somewhere along the line, many businesses decide that they should chase bigger customers.  Bigger customers buy more stuff, create more revenue easier than many small customers and in general seem like a good thing to focus on.
 
Maybe so, maybe not.
 
Here are two examples of businesses I’ve actually known that went the bigger is better route.
 
One business sold printing.  They had a very diverse customer base.  That base could be easily serviced with ink that was easy to buy.  So far so good.  The business owner worked very hard to build up a relationship with a very large customer.  And he succeeded.  Still so far so good.  Over time, the new large customer grew its volume with our printer.
 
The larger volume meant the owner had to spend more time on the new business and he began to not have time for the older, smaller businesses.
 
Guess what happened.  The new big customer started to demand specialty inks in colors to go better with their products.  Our printer sourced them and bought them.  Pretty soon our printer had a huge stock of specialty inks and very little of the old colors.  Then the shoe dropped.
 
The new big customer found a cheaper printer and stopped buying from our guy.
 
Here was the outcome.  Our printer had an inventory of ink he couldn’t sell and since he’d lost most of his smaller customers didn’t have enough business to continue.  He went out of business.
 
The second business represented and sold a line of very high quality camping gear. Like the printer he worked long and hard to develop a relationship with a major national retailer.
 
For a couple of years everything went well.  The retailer bought more and more product and our business made more and more money.  Over that time the retailer became about 90% of our guy’s volume.
 
Guess what happened. One day our guy walked into the buyer’s office at the retailer.  The buyer looked at him and said they were no longer allowed to talk with each other.  Our owner asked why and was told that his line was now a “house account”.  (If that’s not a familiar term it means the retailer was now buying directly from the manufacturer with no middle man – our business.)
 
This business never stocked inventory so it wasn’t left with unsaleable products.  However the business had ignored its smaller customers and lost them.
 
Here was the outcome.  Our camping gear guy lasted about a year.  He filed bankruptcy and was out of business.
 
Both of these examples illustrate what are called concentrations.  You should concentrate carefully on these concentrations because while they may seem good on the front end, they may not end up so well on the back end.
 
Check you accounts receivable regularly and start to ask questions if a particular customer starts to represent 10% or more of your total credit sale volume.

​

• Do detailed explanations make your eyes glaze over?

 

• Do you hate digging into the details of your financial statements?

 

• Do you understand your financial statements?

 

• Do you cringe when you think about a bank appointment?

 

• Do you let the bookkeeper sign checks?

 
If you answered yes to one or some or most of those questions your business may be heading for financial trouble.
 
Many business owners, if they are really honest with themselves would answer yes to most or all of those questions.
 
Why?  Because many business owners see themselves as visionaries, smarter than everyone else or simply bulletproof.  Many believe they have hired people to do all the things they don’t want to do (like the things in the questions).
 
You have to have the details.  But, you are allowed to ask that they be presented concisely and understandably.
 
Develop a brief executive summary of your financial statements.  One or two items should be reviewed daily, most can be reviewed weekly.  Question anything that doesn’t seem right to you.  Demand answers within 24 hours.
 
You are either asking the bank to loan you money or continue to loan you money.  They are entitled to have factual honest answers and explanations…they are taking a chance on you no matter how long you’ve been with them.  You should have those answers immediately available.
 
 
I don’t advocate delegating check signing in smaller businesses.  I’ve seen dozens of cases where that practice led to theft of one kind or another and the loss of the business due to a lack of cash.
 
If you stay on top of the details, yes even the ones you don’t want to bother with you’ll be able to answer the tough questions when they arise.  You’ll be better able to anticipate needs and changes.  You’ll also be better able to blaze a trail for more profitable operations and growth.  And, you’ll be better able to avoid financial trouble.
 

Much has been written about the difficulty small businesses have had obtaining loans. 
​
Whether credit is easy or difficult to obtain may not be as important as understanding what happens when the credit has been obtained.

​Let’s flash back to 2005 – 07 and consider what might have happened to a loan to buy say a bulldozer.

Remember 2005 -07?  Times were good particularly in the real estate industry.  Houses, shopping centers and all sorts of commercial buildings were in the works.  Lots of dirt had to be moved so lots of dirt moving equipment was needed.  Suppose you bought a dozer back then and didn’t look forward?  You probably did your homework and could economically justify the purchase.  (Sure you could have leased, but this is about buying.)

For a while, cash flow made making the payments easy as you had figured.  BUT, then came the bust.  OK, you had enough backlog that the payments were still covered.  BUT, a few months in, the backlog was absorbed and the payments started to be harder to make.  At some point you may have made the decision to either get behind with the lender or ask for a refinance.  Facing a problem loan, the lender may have agreed.  So what happened…unfortunately you bought a little time without solving the problem.  (To add interest, suppose this isn’t your only loan.)
 
A few more months go by and cash flow is really beginning to shrink.  Unfortunately the cash consuming obligations are still there.  Maybe you wonder if the lender(s) will let you go on an interest only program for a while until the work picks back up.  So, you ask them and amazingly they agree.
 
Problem solved this time…right?  Not so fast.  Since you’ve had trouble making your loan payments you’ve probably had trouble making other payments too.  Actually you’re probably behind on everything including (I hope not) payroll taxes.
 
Finally work flow starts to improve.  Jobs that were on hold start up again, you can use the bulldozer rather than just feed it and you can actually pay for it again.  Or can you?
Remember the interest only deal?  How many more deals like that did you make? How many suppliers and other creditors now expect you to make good on your promises?  How do you plan to make good?
 
You might be tempted to say “I wish I hadn’t bought that dozer.”  Wrong answer.

​Considering the millions of words written about good customer service it’s probably safe to assume that most of us put a premium on good or great customer service.  We make sure our customer contact people are well trained and understand and buy into our service objectives.
 
But let’s take a look at the delivery part of the customer service experience and how it might actually hurt cash flow.
 
First, how do you deliver, your own vehicle fleet or common carrier?  If the answer is your own fleet the next question is do you know and factor in all of the costs of operating that fleet?  Maybe, maybe not.
 
Every cost of operating a business can be broken down into a basic unit cost.  It can be a very general cost or it can be a very refined cost.  Delivery is a good example of a very refined cost since it is best expressed as cents per mile with several factors combined to make a dollars per mile cost.
 
For the period of 2008 – 2015, the American Transportation Research Institute reported that the average cost per mile of operating trucks was $1.6203.  Of that, the average fuel cost was $.5483 per mile.  Fuel is far and away the largest component of delivery cost.  The same report indicated that the average fuel consumption was 6.3 mpg.
 
Let’s say your truck averages 100 mile per day.  At the average cost per mile, fueling that truck costs you $54.83 a day; $274.15 a week; $1,178.85 a month; and $14,146.14 a year.
 
On top of that are driver costs, tires, maintenance, insurance premiums, licenses and don’t forget the actual truck payment itself.  In other words, the daily 100 miles cost $162.03.
 
OK, OK enough math for now.
 
Now that we know what our deliveries cost we can weigh the value of that service, or can we?  One thing that can be easily overlooked in understanding delivery cost is routing.  Is the truck (or are the trucks) going back and forth across town all day?  Is one item being delivered today that could be combined with other things and delivered tomorrow?  Is a straight truck being used when the salesman’s car would be enough?  Do the customer service, sales and dispatch people talk to each other?
 
Any loose end in the delivery process can add miles.  Added miles mean more cost.  More cost is the nemesis of good cash flow.  So maybe an extra 50 or 100 miles here and there doesn’t seem to matter…but it matters a lot.

Many of you may think this title is a mistake or misleading or just plain stupid.  Of all the complaints business owners have made, this particular complaint may not only be the most baffling, but the most indicative of a serious cash flow problem or problems.  The truth of the matter is that it is COMPLETELY possible for a company to sell its way into a very deep hole.  Unfortunately selling out of the hole may be harder than selling into the hole.

Let’s take the idea apart and examine some of its implications.

A conversation between the production manager and the sales manager might go something like this…” I can build them if you can sell them” - “I can sell them if you can build them.”    Production gears up for much more work.  Sales quotas are raised and the race is on.  Soon the orders are flooding in and product is being built and shipped at a record pace.  The sales graph looks like a hockey stick and management is very pleased.  The business model appears validated from the standpoint that there is real interest in and desire for the product or service.

It would be great if the last paragraph was the end of the story.  All too often though, this scenario is just the beginning of a much sadder story.

Let’s take a look at the two statements that began the race.  “I can build them if you can sell them”.  Product can be built in any number of units if adequate resources exist.  The tricky part is assessing the adequacy of the resources.  Is there surplus plant capacity, or will additional machinery, space, employees, or other needs have to be acquired?  If so, at what cost and at what terms will they be acquired?  Does the operating budget allow for and is discretionary cash flow available for these types of additional expenses?  Is reasonably priced and appropriate financing available?  Are there any “hidden” or other unexpected costs?

“I can sell them if you can build them”.  The question pattern here is very similar.  Are the resources adequate?  Are more sales people needed?  What will their ramp up time cost?  Will the peak demand time decrease before the sales force becomes fully effective?  What about additional travel and entertainment expenses?  How quickly can those additional costs be recovered?  Are there any potentially negative customer service implications?  What about the company’s credit philosophy and practice? 

Over the years many companies have fallen into the holes created by not asking and answering those and similar questions.  As an owner, you may think adequate plant capacity exists.  But, don’t loose sight of the fact that tools are more likely to break down under heavier use.  Frequently, when production is dramatically increased, routine maintenance may be neglected.  So, when the tool breaks, not only is it out of production and generating revenue, it may have to be repaired or replaced thereby creating unplanned expense.

If additional space was needed and staff hired to meet the production requirements, was that space and staff obtained with an eye to the future?  What happens if the additional production is a fluke and sustainable demand for the production doesn’t exist?  Are there lease commitments that cost money?  Can the new staff be easily eliminated, or will it continue to be a drag on the income statement?

In most industries it is very difficult to rapidly and significantly increase sales without some relaxing of credit standards.  Relaxed credit standards lead to a longer collection period or in other words a longer cash-to-cash cycle.  Relaxed credit standards frequently also lead to increased credit losses.  Your company may easily have a thirty day money demand and a forty five or more day cash to cash cycle.

Credit and collection policies are very important and must be carefully considered when planning a dramatic volume increase.  Your company needs a clear and practical credit and collection policy which sets out your expectations of your customers as well as your employees.  Your customers should be expected to pay on time.  Your employees should be well trained in good collection techniques to help you identify and build increased business with your GOOD customers and promptly collect the money due from those customers who aren’t so good.  GOOD customers buy product and pay on time.  Not so good customers buy a lot of product and pay when they see fit.  There’s a big difference between the two that a sound credit and collection policy can help identify to your profitable advantage.

Increasing sales is fundamental to growing a business.  However, poorly planned increased sales can lead to cash flow problems and other financial difficulties.  Dramatic growth without proper planning can easily leave an owner saying “we’re selling more than ever – but we’re broke”.

One of the very first things I review when either called into a troubled company or appointed as a receiver are a business’ discretionary expenses.
Unlike utilities, insurance, rent or mortgage payments, payroll and other fixed costs, discretionary expenses have to be paid for with left over cash.
Delivery trucks, new machinery and equipment, business (and personal) vehicles, and luxuries all fall under the heading of discretionary expenses.
Let’s take a look at a couple of these items and examine some of the ways these discretionary items can impact cash flow.
Delivery trucks are essential, but how much delivery truck is essential?  Size, engine choice, transmissions are fairly simple.  But the graphics package cost is discretionary and has to be weighed along with the unit value as an advertising piece, and what consequence the graphics package may have on the truck’s re-sale value.
Hypothetically let’s say the graphics package adds $2,500 to the truck’s cost.  It may really be $5,000 because if it has to be applied, someone will have to remove it at sale time.  While that may be OK for one new truck, suppose you are replacing a fleet?
Let’s say you want to make 15% on an investments like graphics packages and let’s say you have 10 trucks to set up.  Even if you are buying used trucks there is a substantial unit cost.  At $5,000 each graphics will cost you $50,000.  That means the graphics have to generate $57,500 in new revenue to hit the return target.
Discretion, better use discretion.
Machinery and equipment can put a big dent in operating cash flow.  Regardless of whether you buy or lease there is a continuing cost associated with having new equipment.  The big question is this…do you really need it?
Over the years I’ve seen many business owners buy or lease equipment based on a perceived need.  The difference between a perceived and a real need can easily be influenced by the discretionary spending profiles of others.
Let’s consider a machine shop that makes specialized parts for an (insert your own favorite) industry.
Our subject shop has adequate machinery and equipment to adequately handle current and some additional demand.  All of a sudden a new gizmo takes the industry by storm.
Our shop can take its share of the new volume without adding anything, OR it can acquire more equipment to get even more of the new demand.  Suppose it chooses the latter.
There will be some lag time between placing the order and taking delivery of and putting the new machine into production.  More important, there will be additional expense in acquiring and bringing the new machine on line and into production.
If the new gizmo’s a fluke our shop is out a lot of money in acquisition and financing costs for a machine(s) that cannot now pay its own way.  (The same holds true for adding shifts.)
Discretion, better use discretion.
Now we’re to the fun part: cars, boats, airplanes and sports tickets.  All of these are paid for with discretionary money.  I could do a paragraph on each but instead let me suggest that you carefully evaluate how much money these toys REALLY make your business over the course of a year.
You choose what your target return is for a discretionary expenditure.  If it’s zero and your business is wallowing in cash it may not matter.  But, if your business fortunes could unexpectedly turn down and you are left with a lot of expensive discretionary items life could become difficult very quickly.

Why did we start, buy, or otherwise go into business. We all know there are many reasons. A personal interest that grew beyond an avocation phase is one reason. Corporate downsizing and the need to generate living cash is another. Maybe it was involvement in a family business, which became ownership and management through the death or disability of the controlling shareholder. Perhaps it was simply an idea for a "better mousetrap". All these reasons are possible and the list could easily be made much longer.
 
Regardless of the reason(s) we started up, it's what we do day-to-day that determines the ultimate success or failure of our enterprises.
 
We have all heard of (and presumably done something about) the importance of hiring good accountants and lawyers. These professionals keep us out of trouble by helping us understand and comply with an array of laws, guidelines, position papers, legislative issues etc. They help with taxes, codifying and arranging year end matters and facilitate trade-name registration, copyrights, patents, succession and estate planning, and even the occasional lawsuit. They don't necessarily keep us out of trouble with ourselves.
 
Over the last several months of writing these columns I've talked repeatedly about the importance of cash, particularly the net cash operating position. To briefly reiterate, it's cash that pays employees and associates. It's cash that maximizes the ability to buy goods and services at prices that allow a good competitive position. It's cash that allows the taking of discounts thereby contributing to both above and below the line efficiencies. And, it's cash that is used for discretionary spending.
 
Discretionary spending is the spending we choose to do, rather than the spending we are obligated to do. Since every business has certain expenses it is obligated or required to pay, it stands to reason that discretionary spending comes from non-obligated funds. Pretty simple? Not really.
 
Let's start by looking at some examples of what is discretionary and what isn't. Payments for trucks are contractual obligations. Increasing the amount of the payments by unjustifiable upgrades or options is discretionary spending. Flying on business trips is probably essential for the most part. The best fare is the requirement; the most convenient time (if it costs significantly more) is discretionary spending. Employee health insurance may be required to attract and retain quality employees. But, does the entire premium have to be absorbed by the employer? If not and the employer does anyway, that's discretionary spending. You could also think of it as "lifestyle" spending.
 
Any or all of the examples and many more are possible, perhaps likely, and not necessarily wrong. The test of discretionary spending comes from an analysis of the source of the funds in light of an owner's perception of the business' future needs.
 
Businesses have lifestyles just as individuals have lifestyles. Lifestyles require cash. The key question is which source of cash does a business choose to support its lifestyle?
 
Cash comes from four sources:

• Successful operations
• Conversion of assets
• Contributed capital (inside or outside investment)
• Debt

Let's consider the sources.
 
Successful operations
These funds are generated by well-managed businesses that have developed recurring sustainable sources of revenue. Cash from successful operations can be reasonably well projected based on past performance and realistic expectations. Since the source can be predicted so can the uses be predicted. Capital acquisition and other cash-use budgets can be drawn and provided for. The REAL discretionary income comes below those budget lines.
 
Conversion of assets
It may make perfectly good sense to sell off surplus inventories, machinery and equipment, or old no longer needed personal property. But remember, once it's sold its gone. The cash from the sale may be used to bolster current operations or help support discretionary spending. However, selling perfectly useable property to support discretionary spending is WRONG, and bound to lead to trouble.
 
Contributed capital (inside or outside investment)
Businesses sometimes use equity investment to support current operations and discretionary spending. That may be okay for an early phase start-up. But developing a lifestyle from the abundance of cash an equity investment creates can lead to DISASTER when the business takes longer to generate positive net cash operating income than projected.
 
Borrowing
Purpose credit, real estate loans, and working capital financing all have their place in the contemporary business world. The big question is why is the borrowing needed. Is the machine too expensive to buy outright, but easily fits into the required spending monthly allocation? Can the building be bought for less than rent and there are sufficient long-term benefits to justify the purchase? Do the payments easily fit into the required spending monthly allocation? Does the availability of working capital financing allow better purchasing, discount taking, or other cash enhancing features?
 
OR
 
Has lifestyle spending become standard operating procedure? Is the lifestyle spending being supported by borrowing of some sort rather than successful operations? If yes is the answer to either or both of those questions, a business runs significant risk of not being able too properly handle emergencies or other unexpected events. In short, financing a lifestyle can be risky business.
 
Mediation Services would welcome the opportunity to discuss this or any other cash related matter concerning your business. Please feel free to contact us. We will reply promptly.