Managing Accounts Receivable - Cash Flow is King Regardless of Size
Greg Dowell • August 8, 2024
Not much is of more importance than cash flow.
As advisors to businesses of all sizes, from basement tech start-ups to large manufacturing operations and including new businesses and mature generational businesses, our firm has seen time and again how businesses fail because they stopped managing cash flow. An article in the Wall Street Journal recently discussed how a major retailer, Saks, has failed to manage their payments to vendors. After courting a number of boutique small business to supply Saks with unique products, the retail giant has failed to make timely payments for the inventory it purchased and resold to its customers. Several small businesses have learned a brutally hard lesson about the importance of cash flow.
Managing cash flow has many components, with these being the most common and critical:
- Adequate initial funding
- Collecting on receivables
- Making timely payments on payables
- Sticking to loan terms with lenders
- Keeping owner compensation at sustainable levels
When we see businesses struggle, it is typically because one of these elements has been ignored. Let's expand briefly on each of the above:
- Adequate initial funding - Often we see businesses launch on a great idea, but with vastly limited cash reserves. Depending on the model, anywhere from 6 months to 12 months of cash reserves should be available at the outset. New businesses will not have leverage with vendors or customers to get exceptions made. Payroll can never be missed, nor can making payroll tax deposits. We have seen businesses time and again make a conscious decision NOT to make payroll tax deposits with the Federal or State governments, which is typically the start of a death spiral. If there isn't adequate cash to start the businesses before operating cash flow begins, don't start the business.
- Collecting on receivables - Far too many businesses are timid about collecting what is due to them. Sadly, some of this is out of a displaced fear of potential client loss, but clients who will walk away from a business because they are required to pay their bills are not really clients a business should desire. It is very important at the outset to establish a collection process with your clients. Legitimate and respectable businesses will typically honor any reasonable process. To lean on an old cliche, it is also important to avoid throwing good money after bad - don't continue to expose your business to bad customers by continuing to ship products or provide services. Regularly review the business' receivables and manage the ones that are getting stale. The excuse that "they always end up paying" is a poor business practice. The reality is often that they may end up paying something just to string you along, but they will definitely stiff you with a large outstanding balance when they go out of business or change vendors. While it is a thrill for small businesses to deal with the big players, don't lose your good business discipline just because you're dealing with a marquee client (see the Saks reference above). Saks isn't the only big player to get fat off of the little businesses they feel they can shove around.
- Making timely payments on payables - This is the flipside of the above discussion, and there is a little bit of the Golden Rule here - treat others they way you would like to be treated. Stretching payables is an age-old business practice to enhance immediate cash flow, and can be tolerated within reason, but in the end it is a zero-sum game - current cash flow is being enhanced at the expense of future cash flow, unless the plan is to do this in perpetuity, which is no more than a cousin to a Ponzi scheme. Most importantly, valuable time and entrepreneurial energy can be spent needlessly on managing creditors. Stay on top of payables and spend your time growing the business.
- Sticking to loan terms with lenders - Borrowed money is not your money - it's the lender's. Banks will seem like they are your best friend during the courtship process, but banks, rightfully, expect a business to adhere to the repayment terms. Only take on debt if you are confident cash flows will enable the business to repay it timely. Tough times require that a business have frank and honest discussions with the lender; most lenders have some flexibility because they know that business can be unpredictable. Be aware, however, that "banker fatigue" is a real thing. Singing the same song over and over will get the business on a short do-not-lend list. Banks are incredibly reluctant to foreclose or enforce the ultimate repayment terms, but they ultimately will, and that intervention to perfect their loans will be the death knell of the business.
- Keeping owner compensation at sustainable levels - Don't pull more cash from the business than the business can sustain. If anyone has to miss a payroll, let it be the owner. Owners that establish a lifestyle that depends on pulling a certain amount of income from the business have no latitude when a downturn hits - and downturns always hit eventually. Develop a discipline of taking a fair and reasonable amount of salary or draw from the business, but wait to take larger amounts until it is obvious that the business can afford the cash outflow. Similarly, don't saddle the business with non-business obligations. Keep your personal expenses in your personal account. It takes far too much energy to play this silly and deceptive game of expensing personal items through the business. You'll regret you ever did when it comes time to sell your business, or when the IRS audit lottery draws your name.
We hope this reminds you of good business practices. Most businesses don't do everything well. Maybe you will recognize something you can do better by reading the above. It is always a good time to improve your processes.
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As you may be aware, you can't keep retirement funds in your account indefinitely. You generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or 401(k) plan when you reach age 73. Roth IRAs do not require withdrawals until after the death of the owner. Your required minimum distribution (RMD) is the minimum amount you must withdraw from your account each year. You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts). We typically instruct our clients to turn to their investment advisors to determine if they are required to take an RMD and to calculate the amount of the RMD for the year. Most investment advisors and plan custodians will provide those services free of charge, and will also send reminders to their clients each year to take the RMD before the deadlines. That said, it is still good to have a general understanding of the RMD rules. The RMD rules are complicated, so we have put together the following summary that we hope you will find helpful: When do I take my first RMD (the required beginning date)? For an IRA, you must take your first RMD by April 1 of the year following the year in which you turn 73, regardless of whether you're still employed. For a 401(k) plan, you must take your first RMD by April 1 of the year following the later of the year you turn 73, or the year you retire (if allowed by your plan). If you are a 5% owner, you must start RMDs by April 1 of the year following the year you turn 73. What is the deadline for taking subsequent RMDs after the first RMD? After the first RMD, you must take subsequent RMDs by December 31 of each year beginning with the calendar year containing your required beginning date. How do I calculate my RMD? The RMD for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS's "Uniform Lifetime Table." A separate table is used if the sole beneficiary is the owner's spouse who is ten or more years younger than the owner. How should I take my RMDs if I have multiple accounts? If you have more than one IRA, you must calculate the RMD for each IRA separately each year. However, you may aggregate your RMD amounts for all of your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You do not have to take a separate RMD from each IRA. If you have more than one 401(k) plan, you must calculate and satisfy your RMDs separately for each plan and withdraw that amount from that plan. May I withdraw more than the RMD? Yes, you can always withdraw more than the RMD, but you can't apply excess withdrawals toward future years' RMDs. May I take more than one withdrawal in a year to meet my RMD? You may withdraw your annual RMD in any number of distributions throughout the year, as long as you withdraw the total annual minimum amount by December 31 (or April 1 if it is for your first RMD). May I satisfy my RMD obligation by making qualified charitable distributions? You may satisfy your RMD obligation by having the trustee make qualified charitable distribution of up to $108,000 in 2025 ($105,000 in 2024) to a public charity (some public charities excepted). The amount of the qualified charitable distribution will not be included in your income. You may also make a one-time election to make qualified charitable distributions to certain charitable trusts or a charitable gift annuity. What happens if I don't take the RMD? If the distributions to you in any year are less than the RMD for that year, you are subject to an additional tax equal to 25% of the undistributed RMD (reduced to 10% if corrected during a specified time frame).
