Your business will need a lot of cash if you’re paying for stuff before you sell it. If you’re growing fast, this negative cash flow cycle can cause a catastrophe. It almost did for technology giant Dell back in the ’90s.
Verne Harnish explained to me how Dell used to inventory parts and pay suppliers for the gear they kept on hand to make computers when customers called. The company ran short of cash and almost choked on its own growth. Galvanized by the near-death experience, Michael Dell himself set out to remake his company’s cash flow by charging customers before buying the bits and bobs needed to build the computers they ordered. By reversing the typical cash cycle, he was able to use his customers’ money to fuel his growth, which meant he required very little external money to grow the business.
Positive cash flow cycle businesses are more fun to run — and their also way more valuable. If you would like to sell your business one day, you’ll get more for it if you have a positive cash flow cycle. Positive cash flow businesses are worth more because:
1.) acquirers do not need to commit their capital to funding their day-to-day operations and;
2.) the bottom line is fatter because positive cash flow businesses do not incur financing expenses and they often have some investment income to juice the revenue line.
Highspot is a small, Toronto-based publishing consulting company that charges upfront for everything it does. Co-founder Ross Slater explains the company’s payment policy:
“In the beginning, the cash flow helped us get started without a lot of financing. Now we see prepayment as a mutual commitment to the success of the relationship we’re creating with our clients. By paying upfront, the client commits to participating in the process, and we commit to providing value and delivering on the trust they have placed in us.”
Wonder how he gets away with it? Slater explains,
“We have a clear, staged process that outlines how we operate and what a client receives. The fees for each stage are right on our website, which filters out the tire-kickers. We invoice immediately, then do what we say we’re going to do. We insist that this is the way we do business. We’ll walk away from a situation where a potential client won’t agree.”
Watch the short video below where I explain the cash flow positive model. When you charge upfront, your company will be worth more when you go to sell — and more fun to run in the interim.
I love it, John. I’m sold. I have just started doing this — arranging for payment up front, in part on most gigs, especially with new clients. I was super glad to read about Slater and to read “positive cash flow cycle” in a new light. Thanks.
Thanks TJ. best of luck with your new business
Any opportunity to avoid financing fees to fund cash flow is great for businesses. When selling, people sometimes worry about when to “ask” to be paid – the client says they are committed so work begins but then they get cold feet. With employees to pay and external cost incurred ahead of the first invoice, it can be rough on cash flow, especially with any volume.
Echoing John’s point loudly – be upfront and clear about when you want to be paid and do so in a public forum so it is as plain as day. Changing expectations in the last minute makes customers uneasy and you don’t want to start new relationships on that footing.
This is an excellent cash flow model for small business. Way too many small business owners allow their company to be a “bank” for their customers by extending credit and waiting for payment. Dell would have had trouble surviving if they had not turned that around. Every small business should look at the way they do business and consider a change.
Jeff Ski Kinsey
Good advice. However, Walmart goes one step further. They don’t pay a significant number of vendors until those goods actually leave the store in the arms of consumers.
love your analogy of “small business being used as a bank”. Thanks for joining the conversation.
Trust is the key ingredient when asking a client to pay up front. They have to believe you’ll deliver what you said, when you said.
Great article John, As a business coach and consultant, I’ve been doing this for years with great results. My clients pay less for paying in advance, and it helps them to honor their own commitment to making positive and profitable changes in their businesses because they’ve already invested in it. Plus, our relationship doesn’t have to be compromised in case they run into financial difficulties. It’s a win win all around.
I agree, trust is the most critical currency. Asking to be paid up front can be a great acid test for the trust you have built: if they say “no”, you know you have work to do. If they say “yes”, then you can feel confident you have a trusted relationship. Thanks for joining the conversation.
Great info. thank you for sharing. I would like to ask about how one can make a small fashion company into a positive cashflow. the culture of this business is to pay after making the garments that have been ordered. Any ideas suggestions. Thanks again for a great post.
Super posting. Great advice.
Thanks, Mike Wilke
1- most businesses work on a “days supply” inventory model, so when you grow you need to increase your parts by the same percentage. This is why Michael got the cash shorts (he doubled his business in the early 90’s and needed to buy an additional $300 million in parts).
2- when last I heard, Dell was operating on a 7 hour (not day) supply of parts. When I was at Dell, they were paying suppliers on a 30 day cycle. They were building and charging in a little over 2 days, so they were cash positive the other 27 days!
3- additionally, at the time, computer parts (those in inventory and those in PCs built for inventory) depreciated at 2% per week, so companies like Compaq, who in the early 90’s had 4 months supply of parts and computers, were selling them with parts already about 24% less in value than when they bought them…
Now that’s the makeup of a great business in an opportune market! J
PS the “Just-in-time” modeling tool that enabled the 7 hour supply of parts both cost millions and relied on the suppliers feeding data to Dell to insure a smooth flow of parts… and sometimes demand outstrips inventory, at one Q4 earnings meeting, Michael stated that the company had failed to deliver on over $300 million in orders because of parts shortages… ooops! J
The positive Cash Conversion Cycle is definitely a plus for any business. It is like getting free financing and Dell’s direct business model has enabled it to master this.
However, this does not work for everyone and is not always trivial for small businesses. There may be a trade off with customer experience and you may risk losing the customer to competition with more favorable payment terms.
The ability to maintain a positive Cash Conversion Cycle is a function of the size of your business compared to your suppliers and customers. The bigger you are the more successful you can be in maintaining a positive cash conversion cycle without losing your customer or supplier.
If your business caters to an individual consumer, then it makes sense to charge them upfront. However, if your customer is a business (especially bigger than yours), then your customer may have a higher negotiating power on payables than you do.
(The same applies to your suppliers. If your supplier is smaller than you or has a lot of competition, you can negotiate a late payment to them. But if the supplier is bigger than you and sells something that does not have competition then the supplier has a higher negotiating power and it may not be as easy to maintain the positive cash conversion cycle)
As someone else pointed out, the structure of your industry will determine your leverage.
Having said that:
– Don’t think of it as all or nothing. The real goal is to IMPROVE your cash flow. Perhaps you can get some of it upfront in some situations.
– Even more important: Put yourself in a stronger position. To “get paid like Michael Dell” DO what he did. Don’t compete on the playground already waiting for you. Build your own.
You do this by broadening what you pay attention to. In other words, if your competitors focus on providing A, B and C, look at your customers and ask “What ELSE would they really want? And how can I provide it?”
Then build that advantage and you’ll find that even if you’re facing larger competitors you’ll have more leverage.