Entrepid

From Seth,

“If you work in an urgent-only culture, the only solution is to make the right things urgent.”

Amen!

This is Part 1 of a planned series on managing your business during a recession.  Subsequent parts will be linked at the bottom of this post as they are published

I don’t have a crystal ball or some special insight into the macro economy that allows me to say we’re in the beginning of a recession.  The classic definition of a recession is two consecutive quarters of negative GDP growth, and since most recessions are short-lived, we often don’t know for sure that we’ve been in one until it’s over.

What I do know is that how people will react to the possibility of a recession has many of the characteristics of a recession - and can even bring one on .  Now is the time for judicious management, and if not actually growing now, at least laying the foundation for significant growth during the recovery.  Whether we experience an actual recession or just a perceived one, there are things you can do to protect your business and even make progress during turbulent times.

Cash is King - Don’t Let Your Customers Keep Yours

This is always good advice no matter the macro environment, but during a recession it’s doubly important.  When businesses sneeze, their vendors are often the first to catch a cold.  Delayed payments become common and bad debts increase.  You don’t want to be the vendor left holding the bag.

If you begin to have customers and clients who used to pay on time but now don’t, it’s a good sign they’re experiencing difficulty.  Many will try to ride out hard times by borrowing to fund operating deficits - borrowing from vendors through increased A/R and stretched-out payments, borrowing more on lines-of-credit, maxing out on credit cards.  As soon as you see this happening with a customer, you must be pro-active.  Waiting will just get you stuck at the back of the line and you may never get paid if your client goes bankrupt.

Here are three things you should do right away with slow payers:

• Lower their credit limit with you, and/or
• Put them on COD.
• Intensify collection efforts and don’t let up until you get paid.

Awhile back I did a series on 15 Things You Can Do To Get Paid Faster.  Now would be a good time to read it and implement some or all of the suggestions.

Restructure Your Borrowing

The Federal Reserve has been on an interest-rate-lowering tear lately, but it can’t, and won’t last forever.  Inflationary pressure and the weak dollar will force the Fed to raise rates again as soon as they feel the danger of a recession has passed.

Take advantage of the current situation and look at your business borrowings to see if you can lower your interest expense and/or stretch out payment terms to preserve cash flow. 

Specifically:

• If you’ve used a first or second mortgage to finance your business, look into re-financing to lower your interest rate, and/or
• If you’ve used a HELOC (home equity line-of-credit) to finance your business, consider a re-fi into a fixed-rate, fixed-term mortgage to lower your rate and stretch out payment terms.
• If your financial situation is still strong, consider obtaining a fixed-term working capital loan (the SBA has some good options) to pay off higher interest rate credit cards and unsecured lines-of-credit.
• Take advantage of credit card offers with zero-interest balance transfers.

If you haven’t sat down with a good banker in awhile, now would be a good time to do so.  Tell them you want to restructure your business borrowing and see what they can do for you.  You’ve probably heard about a "credit crunch," but I’m not seeing it in the small business lending arena.  Banks are still lending money to quality businesses.

In Part 2 I’ll be concentrating on Cost Control - the right way.  In the meantime, go collect some overdue A/R!

Here’s the link to Part 2 - Cost Management and the link to Part 3 - Marketing.

Conversation Starter, the free online companion to Harvard Business Review, has a long blog post / short essay on Staples attempt at new strategic innovation.

You should read the whole thing, but here are some nuggets:

…all strategies have a sell-by date. Just because you were a successfully disruptive business doesn’t mean you can’t fall victim to the same forces. Competitors will come, and absent entry barriers, they can simply copy what you’ve successfully done (without all that time-wasting analysis and experimentation to figure out the model, too).

Call that the Microsoft strategy.

Customers will — most irritatingly — take what used to excite them in the past for granted.

Remember, your customer is not your friend.  At its core, the customer-vendor relationship is a commercial one, and the minute you cease to provide value to the customer, they will depart.

But, no law says you have to do business with customers who don’t bring value to you as well.  A healthy business relationship is one in which both sides win.

This is another follow-up to Use A Credit Card For Cash Flow Improvement.  And since I don’t want this blog to be All Credit Cards All The Time, it will probably be the last credit-card-as-cash-flow-improver for awhile.

Here’s what I said about starting with a “clean” card - one with a zero balance:

Next, make sure the balance on the account starts at zero.  You can accomplish this in a number of ways: open a new account, use your line of credit (if you have one or can get one) to pay down the balance, transfer the balance from a higher interest card to a lower interest card, put off some other expenses to free up cash to pay down the balance (you’ll make up the cash flow in short order), etc.

There’s another way to get your current card(s) to a zero balance and save yourself a good bit of interest in the process - interest-free balance transfer.

You’ve probably seen the offers.  Open a new account with XYZ Credit Card Company, transfer the balances from existing cards, and have the transferred amounts be interest-free for the next 9, 12, or more, months.

Here’s how to make it work for you:

• Identify one or more of your existing cards to use as “free float” cards.
• Transfer those balances onto the new card with the interest-free period.
• DO NOT charge anything new to the new card - it’s for the transferred balances only.
• Use the newly cleaned cards for the free float technique outlined in the original post linked to above.
• Use the interest free period on the new card to pay down the balance.

Doing it this way can save some real money and allow you to pay off your balance earlier.

A quick example.  If you have a $10,000 balance on a credit card with an 18% interest rate, it would take 12 monthly payments of approximately $908 to pay down the balance to zero - $10,000 in principal and $900 in interest.  With an interest free card, that same $908 monthly payment would pay off the balance in 11 months, saving $900 in interest.

So, next time one of those balance transfer offers come in the mail, consider it time to begin the process of getting interest free float and improving your cash flow.

This is a follow-up post to Use A Credit Card For Cash Flow Improvement.

While not as popular as it use to be, some vendors still offer payment terms of 2%-10, net-30 instead of the more “normal” net-30.  2%-10, net-30 means that your invoice is due in 30 days, but if you pay it within 10 days instead, you get to deduct 2% from your payment.  Vendors who offer these terms do so in order to speed up their collections, but they know that most customers will not take advantage of them.

For businesses who have the cash flow to do so, paying in 10 days and deducting 2% from the payment is one of the best returns you can get on your money.  In essence, the vendor is borrowing money from you for 20 days (the difference between 30 days and 10 days) and paying you 2% to do so.  Since there are 18.25 20-day periods in a year, this works out to an annual interest rate of 36.5%.  Try getting that on your money market or CD!

This is a compelling argument to taking advantage of early pay discounts, but most small businesses don’t have the cash flow.  This is when the technique outlined in Use A Credit Card For Cash Flow Improvement can be powerful.  If you haven’t already done so, this would be the time to read that post.

Now a business owner can choose between “paying” a vendor in 75 days, or paying in 55 days and taking 2% off the top.  Either way will definitely improve the cash flow of your business, but I lean toward taking the discount.

And, if you have a vendor that won’t extend terms to you and has you on COD, they’ll often extend the 2% discount to you if their normal terms with other customers are 2%-10, net-30.  All you have to do is ask.

Mark Cuban, of Dallas Mavericks fame, has a post on his rules for startups.

My favorites are:

1. Don’t start a company unless its an obsession and something you love.

2. If you have an exit strategy, its not an obsession.

4. Sales Cures All.  Know how your company will make money and how you will actually make sales. (emphasis mine)

 

He also links to a post, How to Save Money Running a Startup, by Jason Calacanis that has some really good tips for cost control that can be used by an existing small business, not just a start-up.  Be sure to read the comments too for some other good ideas.

Edit for clarification - By default, an LLC is treated for tax purposes as either a Sole Proprietorship (single owner LLC) or a Partnership (multiple owner LLC.)  You can, however, elect to be treated as a corporation and then elect that corporate status to be S Corp.  These are two separate elections and the IRS must approve your elections before they become effective.  There are rules and deadlines to satisfy, so consult your tax professional.

The vast majority of LLC’s I see have not done the elections for S Corp status, and are therefore paying more in payroll taxes than necessary.  Hence, the following article.

If your business is organized as an LLC, you have a choice of being taxed as a Corporation or as a Partnership.  Most LLC’s choose the latter through inaction.

If this is you, you’re wasting money on FICA taxes.  All of the Guaranteed Member Payments and the net income for those actively engaged in managing the business are subject to FICA (Social Security and Medicare taxes.)

The profits of an S Corporation are NOT subject to FICA.  Here’s how the two compare:

For simplicity, let’s assume you are the sole owner of your LLC and you actively manage the business.  The income to you (Guaranteed Payments and/or net income in any ratio) is $80,000.  The entire $80,000 will be subject to the FICA self employment tax of 15.3% for a total of $12,240.  Half of this will be deductible from your income tax - worth approximately $1,836 in the 30% tax bracket, for a net cost of $10,404.

An S Corp is Treated Differently

Salaries paid to an owner of an S Corporation are subject to FICA - the company pays half and the employee (owner) pays half.  The total is still 15.3%.

Here’s where it gets interesting.  The profits of the S Corp are NOT subject to FICA.  Let’s see how our example changes.

Let’s assume the same $80,000 in income, but this time half ($40,000) is paid as salary and half is allowed to flow through to the owner as profit.  Both halves of the FICA total $6,120 - half of the total for the LLC.  The half paid by the corporation ends up being a tax deductible expense, so at the same 30% income tax bracket, this is worth $918.  The resulting total is $5,202 - a savings of over $5,000.

Don’t Get Greedy

You are probably thinking that if splitting your income 50/50 between salary and profits is good, splitting 80/20 or 90/10 must be even better.

All things being equal that would be the case, but the IRS knows this too.  There are rules in place that require your salary to be "reasonable."  What’s reasonable is subject to interpretation, so you should consult your tax advisor.

You May Still Want an LLC

There could be some other reasons why you want an LLC, even though it costs extra FICA taxes.  You should consult your attorney or CPA.  However, for most business owners I believe an S Corporation is the way to go.

Proper use of a credit card can gain you an extra 30 or 40 days of float on your accounts payable - WITH NO INTEREST EXPENSE.

Most small business owners are no strangers to credit cards.  They are often the borrowing of choice for things that a line of credit would usually be used for - purchasing inventory, paying for expenses while waiting for a big check from a customer, paying travel expenses, and the like.  However, most of the time the credit cards aren’t used properly and substantial interest costs are incurred.

There is a better way.

Necessary Conditions

The single most important thing to have to avoid interest expense is a credit card with a grace period.  This is an account that doesn’t charge interest if you pay off your entire balance by the due date.

Next, make sure the balance on the account starts at zero.  You can accomplish this in a number of ways: open a new account, use your line of credit (if you have one or can get one) to pay down the balance, transfer the balance from a higher interest card to a lower interest card, put off some other expenses to free up cash to pay down the balance (you’ll make up the cash flow in short order), etc.

Then, identify vendors who are willing to extend normal credit terms AND THEN will accept payment by credit card on the outstanding invoice.  You don’t need to tell them why you’re doing this, just ask them if they’ll take a payment by credit card.

Finally, have the discipline to manage your credit card account(s) and pay off the entire balance each month.

How to Get Extra Float

The trick to maximizing interest-free float is to time your credit card charges with your billing cycle.  Most accounts have a 30-day or 1 month cycle for accumulating charges and then you have 2 or 3 weeks in which to pay the bill.

Be careful about monthly closing dates.  Some accounts will have the same closing date every month, but some will do a 30-day or 28-day cycle.  A quick look at your account online will tell you when the next closing date is.

Just AFTER the beginning of a new billing cycle is the time to pay vendors or charge other expenses like airline tickets, office supplies, etc.  You then have 40 or 45 days to pay the bill without incurring interest charges.

An Example

John, the owner of Acme Widgets needs to order a stock of widget parts for inventory.  Acme Widgets has 30 day terms with its supplier and a credit card account with an interest-free grace period.

It’s now the 13th of the January and a new credit card billing cycle begins on the 15th.  John waits for two days to place his order.  (For our purposes we’ll assume immediate delivery and invoicing by the supplier.)

On the 15th of the February, John pays the supplier’s invoice by credit card.

On the 14th of the March (two months after having received the inventory) the credit card billing cycle closes and Acme Widgets has 15 days to pay the bill without incurring interest charges.

On the 29th, John pays the credit card bill online.  The result is that Acme Widgets didn’t use it’s cash to pay for the inventory until 2-1/2 months after receiving it.  With good inventory and accounts receivable management, Acme has already sold, and been paid for, the inventory it sold before "paying" for the inventory.

Free Money

Not exactly "free", but at least interest-free money.  Credit card companies allow for interest-free grace periods because they know the vast majority of their customers will not take advantage of it.  You can use this to your advantage.

If you’re jumping in mid-stream, Part 1 (with the complete list) can be found here.

15) Make Collection Calls as Soon as Accounts Are Late

If you’ve done all the other things to insure prompt payment this shouldn’t happen very often.  But, in spite of your best efforts there will be times when a customer is late with a payment.  Call (don’t email) right away.

Sometimes things slip through the cracks and being pro-active will get them back on track.

Sometimes you’ll have a client experiencing temporary cash flow difficulties.  You WILL want to know this immediately so that you can take appropriate action.  This may be the time to put them on COD for the future if it looks like the difficulties will not be so temporary.

You would rather find out now instead of when you have an invoice that’s 60 days late, another that’s 30 days late, one that’s coming due in a couple of days and an order that just left your warehouse yesterday.

Bonus Item

16) Cut Off Chronic Late Payers

This one won’t necessarily get you paid faster, but it will protect your cash flow.  Chronic late payment, even after all your best efforts to establish on-time payment, can be a signal that the client is experiencing financial trouble.  You don’t want to be left holding the bag on large A/R balances if they go into bankruptcy.

Cutting off a chronic late payer usually means putting them on COD status.  However, if they can’t, or won’t, pay COD, you need to willing to walk away from the relationship.

If you’re jumping in mid-stream, Part 1 (with the complete list) can be found here.

12) Accept Payments Electronically

The most common methods of electronic payment available to small businesses will be credit cards, PayPal and check-by-phone/check-on-line.  All of these methods have costs involved, but having the cash in your checking account sooner can make it worthwhile.

For larger payments wire transfers can make sense.  Again, there are costs, but for larger payments - several thousand dollars and higher - the costs are generally lower than credit cards, PayPal and check-by-phone.

13) Send Thank-you’s

A quick email to your client’s A/P person thanking them for timely payment goes a long way toward developing a friendly business relationship.  Remember, people like doing business with people they like.  Be likable.

And, for going above and beyond the call of duty, send a hand written note.  You will be remembered favorably.

14) Deposit Checks Right Away

It makes no sense to go through all the effort to get paid promptly and then sit on the check for several days before depositing it into your checking account.  A check is just a piece of paper until your bank makes the funds available to you.

Something else to keep in mind.  Except for the largest companies, the person who pays invoices and the person who reconciles  the checking account are in physical proximity and talk to each other.  If you develop a reputation as someone who holds checks for deposit, they’ll be less likely to pay you quickly.  After all, you must not need the money that badly if you can afford to hold checks.