To Improve Cash Flow, Don’t Miss the Most Effective Remedy
December 7, 2018
Articles like this--“5 Tips for Boosting Low Cash Flow”—frustrate me. For most businesses with poor cash flow, they miss the most obvious solution: pricing.
Here are the five suggestions mentioned in this article:
- “Take Out a Fast Loan”
- “Speed Up Receivables”
- “Make Spending Cuts”
- “Take Out a Line of Credit”
- “Make an Investment”
For the most part these suggestions may seem reasonable, but let’s look at each one by one:
- “Take Out a Fast Loan”: The reference here is to online loan services; RISE is the one mentioned as an example. I clicked through to see what RISE offers: loan amounts up to $5,000 at an APR of almost 60%. For most cash-starved businesses, a maximum loan amount of $5,000 isn’t enough to solve too many problems; that’s before you start talking about the cost of that loan (over $3,000 of interest). For a capital improvement project with a very defined return for a business which can’t get bank financing, these loans can work. The risk could be losing the business entirely to a creditor.
- “Speed Up Receivables”: Collecting receivables faster is always a good strategy to pursue. If you don’t have good repayment terms and conditions already established, however, then collections are much more difficult.
- “Make Spending Cuts”: Spending cuts are a one-time benefit. Once you’ve made the cuts to expense fat, there’s nothing left but muscle to cut. Further, spending cuts, improperly executed, send a poor message to employees about the viability of the company they work for.
- “Take Out a Line of Credit”: Like the “fast loan” solution, loans must be repaid. If all you end up doing with the proceeds of a loan is producing more at the same subpar profit margin, then you’re just making the problem bigger, not to mention now being on the hook to a lender for that loan.
- “Make an Investment”: Here’s the most puzzling solution mentioned. My experience with business owners struggling with their cash flow is that they are all in with their business. They don’t have a lot a excess cash laying around to “make an investment,” either inside or outside the business, to provide additional income.
All of these “solutions” have sizeable drawbacks and risks, whether in execution, effectiveness, or both.
What’s missing is the most obvious and long-lasting answer: pricing. It's not just my opinion; it's an accounting fact.
In a 1992 study published in the Harvard Business Review, researchers from McKinsey & Co. examined the financials of 2,463 companies in the Compustat database of publicly-traded companies. For the average company, McKinsey found that a 1% increase in price (with no change in volume) yielding an improvement of over 11% in operating profit. Their study indicated that price improvement is three to four times more effective than improving volume, and four to five times more effective than cutting fixed costs.
Here’s an excerpt from their conclusion:
The transaction pricing opportunity is real and achievable for most companies today. The investment and risk of capturing this opportunity are low; the keys to success are mostly executional—doing a number of small things right. What is more, advances in information technology tend to make many of these small things easier than ever to do . . . . the payoff is extremely high, both in near-term and sustainable profit improvement and in valuable strategic insights. With its extremely favorable risk-effort-reward profile, improving transaction price management may be one of the most attractive and overlooked profit enhancement opportunities available to most managers.
If your business is struggling with poor cash flow, look for an answer in your pricing. It’s the lowest risk, highest reward answer to your problem.
To view the original LinkedIn article, click here.
©Ray Business Advisors, LLC and John Ray
About me: I’m enthusiastic about how changes in pricing strategy can significantly change profitability for a business and enhance life choices for business owners. I live this passion through Ray Business Advisors, my outside CFO and business advisory practice, in which my pricing is exclusively value-based, not hourly. I work with business owners on how they can change their pricing not just to increase their profits, but better serve the wants of their customers. Click here to learn more or call me at 404-287-2627.