Generating Working Capital

A long discussion is triggered when a cabinetmaker asks how he can free up cash for running his business. Should he seek greater production efficiency, apply for a line of credit, or try to interest an outside investor? September 5, 2006

I have been trying for years to run my business from the cash that we generate from sales. This has me trapped in a seemingly never-ending cycle of trying to complete work based on what I can bill for the soonest, rather than what would make the most production sense. We lose an enormous amount of efficiency because of this, not to mention the stress and pressure. In the past, every time I had any surplus cash I dumped it back into equipment or software. As a result we are fairly well setup to produce, but somewhat hamstrung by cash flow.

The way I see it I have 3 options. 1: Continue to try to build a cash reserve through improved productivity and efficiency. 2: Try to obtain a line of credit from a bank. (I have concerns about my own discipline with credit, and I don't want to end up with a pile of debt with nothing to show for it). 3: Seek a private investor. How does this work? If a person buys stock in a company they put in the money and don't get it back until they sell the stock, unless there are dividends. The cleanest scenario I can come up with is that I go out and sign up the work, approach potential investors with details of the work; scope, hard costs, time frame, payment terms, etc. - more or less per job.

Forum Responses
(Business and Management Forum)
From contributor A:
1. Sounds good.
2. I would say, "last resort".
3. The time and effort would be better spent in acquiring more accounts.

From contributor B:
Am I missing something here? As I see it, your 3 main points are:
"...trying to complete work based on what I can bill for the soonest, rather than what would make the most production sense.

We lose an enormous amount of efficiency because of this...
...every time I had any surplus cash I dumped it back into equipment or software...
...we are fairly well setup to produce..."

Now that you are set up for production, stop funneling the cash back into equipment and software, increase your efficiency and your cash flow problem is solved. You answered your own question.

From contributor C:
You're probably already doing this, but if not, make sure you are on 30 day terms with all of your primary vendors. This tremendously helps cash flow versus paying COD. Another thing to look at is paying for everything possible with a credit card. Under this scenario, you must pay off the balance every month, or else it is not worth the interest rate. The bonus to doing this, depending on the card, is frequent flyer miles or cash back. I'd avoid your #2 and #3 scenarios if possible, although a line of credit can be good to have, so you can move quickly on opportunities that may arise.

From contributor D:
If you have concerns about your own discipline with credit then a private investor is not going to help your situation. You still need to repay both of them. Investors invest for a return on their money. Banks charge interest for a return on their (other peoples’) money.

Stop billing and start more COD. When you give a client a product you are in essence lending them money - money you need now not in 30+ days. You are not charging enough or not getting enough deposit to get you to the next payment. You can be software poor. It’s great for keeping track but it won't drive a screw. And lastly your productivity and efficiency is not up to what you think it is. If it was you would not have the problem you describe.

From the original questioner:
To contributor D: The difference I see between a bank and an individual investor is that a line of credit is not much different than a credit card. The money can be used for anything - tools, food, travel, cars, or whatever. I haven't seen banks show much of a connection between the loan and what it's used for. I have personally, and I know of many other people who have taken out loans thinking they were short term, max out the balance, and then roll it into a home equity loan or other long term loan after 2 or 3 years. In fact, I think that this type of activity is responsible for a healthy portion of the economy these days. What I would want from an investor is someone with business experience who will link the money to performance, and maybe give some helpful guidance along the way and maybe help build the business. I don't think anything like that is available from a bank. I would prefer to generate the cash myself, but I wonder if it wouldn't be more valuable to have some help.

What is the industry standard for a 1 to 2 million a year business (not that I'm there yet, but look to be either next year or the following year)? Do they finance themselves, do they have investors, do they use a bank, or all 3? Our productivity and efficiency are not nearly what they need to be, but I think that a lot of obstacles have been removed and we eventually will be there.

From contributor E:
If you are equipped and productive, then don't borrow. Concentrate on efficiencies and marketing, and know when to raise your prices. 80% of our work is repeat customers, and has been for years. It gets to be a laid back, big buck arrangement on payments - I have learned to not stand around with a hand out when the work is complete. It’s really bad form and looks like begging.

I use patience and a $40,000 line of credit (did $650k last year), so I can appear to be cool about when we get paid. My customers love this - it spoils them and they keep coming back and whether they think it through or not, they pay for it. My bank doesn't want me as competition, so they like it when I use the line of credit. It is more professional to state reasonable terms firmly and simply, and then send statements and notices from there. I expect net 30 days from my vendors, and often take a discount if it is offered. You could do the same with your customers - give them an incentive to pay early.

The reality is that I have learned to let the 30 days come up, then if they haven't paid, faxing a statement is usually enough to get a check mailed. I do know who I can do this with and who not to. First timers are 50% deposit, net 15 days no matter what. Slow pays are the same, and they know it. The line of credit also comes in handy at auctions or shows, but discipline is required, as with any credit. You do have to pay it back. It’s far better than a partner or investor and cheaper - use the line of credit when you need it, but that investor is always there.

From the original questioner:
I completely agree with the laid-back approach. I give reasonable terms, and have had good luck with them holding to it. But without a line of credit, or some sort of cushion, it is sometimes hard to actually be calm and cool about it. And as I said, I often goober up the schedule to meet a pressing cash need, rather than the best work flow, which only adds to the pressure in the long run because we didn't use our time effectively.

Where is the problem in this scenario? I go out and sign up a job. Let's say it’s a complex of 10 townhouses, $40,000 worth of millwork in each, and about 3 weeks each to complete. As an added incentive to the customer, I offer zero down, payment in full upon completion plus 10 days. It seems that these types of terms are typical of a commercial type project. I then approach investor and say "Look, I have this project that requires a revolving $40,000. At the end of the project (approximately 6 months) I pay you back the $40,000 + $5000". They would make 25% interest (annual), but that $5000 represents only 1.25% of the total millwork package. If I make 11.2% profit on the job, I am able to pay the interest and still have $40,000 for the next project.

The biggest question I have is do I find the work first, or do I find the investor first? As I said before, I would prefer that this investor have some business experience to help ensure that we make 12% profit.

From contributor F:
It seems that you seem bent on getting an investor to show you how to run your business, at least the financial part of it. Maybe some business classes or business counseling would be in order. The topic would be money management and cash flow. Try talking to your local SBA (Small Business Administration) or the SBDC (Small Business Development Center). You might also have some luck with SCORE (part of SBA). They may even have some good thoughts about your "finding an investor" ideas, including how to find one.

One mistake that you seem to want to make is to get your company into the credit/banking/loan business. In your last post you said "As an added incentive to the customer, I offer zero down, payment in full upon completion + 10 days".

Why do you want to loan them money? That is what you are doing. These people are coming to you for cabinetry or woodwork, not a loan. Or, are they? Maybe I don’t understanding something here. I always ask for a 50% deposit, 40% before the cabinets are unloaded at the job site, and 10% upon substantial completion of the job. The 50-40-10 terms are written as part of my proposal/contract. In my business, these terms are not negotiable. My cash flow is kept positive this way.

From the original questioner:
What I want to do is disassociate cash flow from product delivery. My goal is to have an amount of cash sufficient to run the business month to month that has nothing to do with what work we have going that month. I do get deposits on most jobs, but if I can help it I would rather not. It gives me more leverage on schedule and change order issues. I don't like being obligated to a customer because they have given me money, but their project is way behind schedule (their issues - not mine) and all of the details have changed. I would like to remove any implication that they own me. The only reason to get a deposit, as I see it, is for cash flow, and if I can do without it, I am better off. As a bonus the customer thinks not giving a deposit is in their favor. Thanks for the tips on SBA. I’m not looking for someone to show me how to run my business as much as some good advice. And we all know how much advice is worth and what you pay for it. I know I have much to learn, and it seems that the best teacher would be one that has an actual interest in my success.

From contributor H:
Why you would take any job without any deposit of any kind is beyond me. Even in commercial work the contractor gets a down payment to begin work. Future payments are tied to performance. The reason I feel you are getting so much work and have such cash flow trouble is because your clients are using you as their bank. Banks have demand notes. They run for 30-60-90 days and longer. You take out a demand note for 30 days for 40 K and tell your banker you'll get him back 45K and he'd jump if he could. But he won't because he would be charging you well over the legal limit. They call that lone sharking in some states. You obviously have issues with your banks. Investors always want their money back and you will have them looking over your shoulder – a lot. What you are asking for does not exist in reality - a silent partner. No partner is ever silent for long.

You need to get deposits from your clients - at least 1/3 and preferably 1/2. But you need to get something. If some of them walk so be it. But they most likely won't. When they go somewhere else they will have to give a deposit too.

From contributor B:
Have you considered outsourcing your receivables?

From the original questioner:
Money is a tool. Like any tool in the shop, we must use it to our greatest advantage. Bill Norlan in “The Business of Woodworks” asks "Where does working capital come from?
First: from stockholders investment.
Second: from retained earnings.
Third: loans or deferred salary draws from owners and officers.
Fourth: loans from our bank (line of credit or specific contract assignment)."

He goes on to say: "Historically, virtually all working capital growth for custom woodworking manufacturers comes from earnings. Also, historically, the woodworker’s successful growth has been accomplished by working hand and hand with a good bank."

It seems to me that an investor or line of credit can be a valuable tool, or it could be the devil in sheep's clothing. Again I wonder, is industry standard to use this resource, or to go without and be self sufficient?

I think I have all three options that I listed in my original post available (at least I will assume so for the sake of discussion). One of the reasons that I would prefer either 2 or 3 is that I would like to have an interested party involved in the decision making - sort of like a seat on the board of directors. Questions like: Do we buy a used molder, new cheap Chinese molder, new mid range molder, or new Weinig with all the bells and whistles? Do we buy lumber by the job, by the month, or take advantage of the best pricing and buy a truckload from the mill, 3 to 4 mos. worth? I don't think this kind of advice is available from a bank.

From contributor I:
Are you looking for a partner or an investor? Let's imagine someone came to you and asked you to invest in a company they had which was just like yours. Let us further assume that you decided to give them the money in an amount such as you would like to receive. Ask yourself two questions:
1) What kind of influence would you want to have over this person's company?
2) Would you be comfortable with an investor having those same influences over yours?

If you already have adequate machinery and systems in place, you should look to the amount of work you have in process. I guarantee that if you cut WIP in half your solutions will become obvious and you will have resources to spare. Think of it like this: A kitchen with 40 cabinets would probably overwhelm my little shop. At the same time we could totally dominate a bathroom vanity with 4 boxes. The trick is to break that 40 box job into ten bathroom vanities. This is simple: Just release the information 4 boxes at a time. With only 4 boxes on the bench it becomes obvious who should do what and that's one less clipboard holder you have to feed. The draftsman-engineer only has to focus on 4 boxes at a time. Fewer boxes under production at one time means fewer headaches – which means each one goes out the door quicker – which means cash comes in quicker – which means less stress – which means it's easier to figure out what the real issues are, rather than what the symptoms are. You don't need to have the ponderosa to build cabinets. Fix the management stuff, then look for the money. Without the management, the money is not going to help.

From the original questioner:
Just a quick response to your comments about:
"Let's imagine someone came to you and asked you to invest in a company they had which was just like yours. Let us further assume that you decided to give them the money in an amount such as you would like to receive.
Ask yourself two questions:
1) What kind of influence would you want to have over this person's company?
2) Would you be comfortable with an investor having those same influences over yours?”

A: I don't have $40,000 to invest.
B: No one is going to come to me and ask me to invest in their business, because of A.
C: There are people out there who will spend $40,000 on a pair of shoes, or a bottle of wine. To some people investing is no more serious than a game of poker at the Elks club. This is not the type of person I would be looking for, but there is a lot of money floating around in this economy that is looking for a home.
D: I want some valuable input. I don't want a partner, silent or otherwise. But I would appreciate the counsel of a veteran businessman (or woman).

From contributor F:
I believe that contributor I meant that you should also imagine that you had $40K to invest in someone else's business. Then you can think through the rest of the question. In other words, put yourself in the investor's shoes for a few minutes.

After reading some more of the posts on this topic, and your last item, D, let me mention what the SCORE acronym means. SCORE stands for "Service Corps of Retired Executives" and is part of the SBA (Small Business Administration). You can do a web search to find the nearest office to you. There are 389 of them around the country. The members of SCORE are successful and seasoned volunteers who should be able to help you through some of these questions with confidential counseling. Some of the 10,500 volunteer counselors owned small businesses. Some worked in major corporations. SCORE also offers online advice (your questions and their answers) as well as online articles that may help. You stated that you do not want a partner, but the advice of a veteran businessperson. This may be your answer.

From the original questioner:
I was just trying to point out that the idea of me loaning $40,000 would be similar to me trying to imagine child birth. It's just not happening. And as with child birth, for some it’s a walk in the park, for some it's, well, like child birth. SCORE looks like it could be the ticket. My thinking is more like this, however. If you see your doctor in the grocery store and ask for advice he might give you a good quick answer, he might not. If you make an appointment, he may fix you up, or may do what is within the parameters of the insurance company policy. If you owe the doctor a million dollars, he'll go through hell and high water to make sure you get better. There is an organization in my community whose mission is similar to what I am describing. They are similar to SCORE in that they are businessmen, but not necessarily retired. You apply for help, and they evaluate your business and decide whether or not to accept you. If they do accept you, they have resources to invest money if necessary, but they also dig into the business to find ways to fix problems and make it grow. And they have a financial interest in the success of the business. I have spoken with them in the past, and at that point they had no one in their group who had any experience with the type of business that I have, so were unable to participate.

So to restate the question:
A: Is borrowing money, or having investors, a natural part of business and business growth?
B: If you do borrow money or have investors, can you expect any contribution to the business from the investor other than money?

Here’s another analogy. A line of credit or other form of investment is like any other tool in the shop in that it's there to make the business more efficient and profitable. But with some other tools you get training, technical support, user forums, etc. Can you expect any support with financial tools?

From contributor J:
I know I'm in the minority but for what it's worth - cash, and cash all the way. If I can't write a check, I don't buy. It has taken almost 3 years to build up enough cash reserves but now that I'm here, I'm glad I didn't borrow money form anyone. Going forward, I get to keep all the rest.

From contributor K:
I would recommend leasing or financing equipment if you have to have it, and saving cash for necessities (payroll, rent).You may not find it as stressful to grow. You are willing to pay interest with an investor, why not a finance company? They don’t look over your shoulder – although you sound as if you may be looking for this. No matter who you choose to help with your business, a Cash Flow Forecast is something that you should be familiar with, as investors and banks will ask for this. Using your numbers from last year, with regard to what you have coming up, it may help you realize a way out of crisis that does not require other money.

From contributor C:
If you have a partner or investor, you have to give something up - control, profits, autonomy, or something else significant. From your posts it sounds like you have issues that can be resolved without giving anything up.

For business advice, you can contact SCORE, or talk with your banker, or join local business associations, or hire a professional coach. To improve cash flow, you can restructure how you collect deposits from your customers; you can decrease WIP and increase throughput; you can get on credit terms with your vendors, and other options.

Having access to cash is very important, but the thrust of most of the responses to your post is that it sounds like your problems can be solved without giving up any ownership or profits. In Hawken's book “Growing a business”, he says he thinks that having too much money can be a problem for a small business (contrary to the popular opinion that lack of capitalization is a major cause of business failure). The reason for this is that lack of funds forces you to find creative and thrifty solutions to problems. This is what I would encourage you to do.

From contributor I:
Contributor C just raised an interesting point that I have not seen considered on this forum - too much money. It's hard to be disciplined when you don't need to be. During the days of the dot-com boom you could literally walk across the river on the back of salmon. My shop, at that time, ran strictly on cash flow. We had so much money we could burn it and we did. When the stock market crashed and 9/11 came along, the phone didn't ring down here for several months. The viability of my organization was seriously in question. It is said that there never was a business organization that became lean until it had to.

From contributor L:
It looks like you are looking for something external to fix your problem. Many of the guys have suggested that the solution is internal - you have the ability to improve without outside help. You want business advice, and are aware of these resources locally, but have not acted upon it. You find reasons why these suggestions won't work. I am not busting your chops here, but I am seeing a lot of resistance. It’s as if there is no good solution, but I am not quite sure we know what you are looking for, or if you know what you are asking.

It sounds like you are looking for an experienced person who is willing to invest (I think energy in giving counsel) in you. If so, this is a noble request. It is like a man stopping and asking for directions. I can tell you that it is frustrating to know how to do good work, and then the business part gets in the way. So many times I have heard, you just do good work and the money will come. Garbage! It takes a good grasp of business sense, human relations, and a mess of other things to make a woodworking business stay alive.

One thing that I would say is be careful about partnering with people whose sole intent is making money. This relationship may take you and your business some place that you would rather not be. You give up a lot of control when you accept money as a solution.

Many people, as a part of their personality, believe that the solution is outside of their own power. These are the people who believe in luck and fate. If they got the job it was because they were lucky or it was their destiny. Or they are struggling because of the big shop down the road or the fireman who works out of his garage. The problem with this kind of thinking is that they believe that there is little that they can do to influence the outcome. It is not until people begin to take control of their situation that things begin to change. And when they begin to see the change, they realize that they can influence the direction of the change.

It is good to seek advice from solid people. You are still in control, and you decide what to apply and what to toss. But I would suggest to you that money is not the issue here. The problem that I see, as an outsider listening to you, is that the way you collect money and schedule your work is causing problems. More specifically, you cannot get the work out fast enough to maintain adequate cash flow. Injecting more money into the equation is just going to give you the luxury of spending more time on the job without getting paid. In this case, you need to change either your disbursements (how often you get paid), how you spend the money once you get paid (if you get a big chunk after a job is over, why is it not enough to carry you over to the next job), or how quickly you get stuff out the door.

In the last situation, some people allow clients to hijack the schedule, and consequently the cash flow. If a $3,000 job keeps monkeying around, you may be occupied when the $30,000 job wants to get started. Without limitations, some people will draw a job out forever. But this affects your cash flow and shop schedule.

Before you take on investors, I would like for you to take a good long look at what you need, and then what you can do about it. I suspect that once you own the situation, you will find a better solution.

From the original questioner:
These are the scores:
1: Continue to try to build a cash reserve through improved productivity and efficiency. 9 votes
2: Try to obtain a line of credit from a bank. 1/2 vote
3: Seek a private investor. 0 votes
I think I'm probably in the "1: Continue to try to build a cash reserve through improved productivity and efficiency camp" also at this point. But I still wonder if at some point in the business some sort of investment shouldn’t be in the plan. And if so, can I expect any sort of support from the investor, whether it's a bank or otherwise? I am definitely concerned about having too much cash, especially credit. Every day I'm presented with possible expenditures which seem like a good idea but are not completely necessary. Things like Yellow Page ads (how may books to be in, how many categories, how big an ad?), any sort of ads for that matter, new tooling, training for me or the shop, increased insurance coverage. I got a bill the other day for Autodesk subscription coverage for $2500 (the first year was included when I bought my design software). This covers some online tutorials and support and every time they have a new release they just drop it in the mail. So now I have both Autocad 2006 and 2007 sitting on my desk, never having been opened. 2005 seems to work plenty well so I haven't had the guts to mess with the new ones. Right now I don't see any sense in renewing this subscription, but then I might miss out on something big. This is why if I was to have investment in the business, I would prefer that it be tied to one particular project, not just an open account that could easily evaporate into thin air.

From contributor L:
It's all about choices. Madison Avenue spends boatloads of money every year trying to make you part with your money. Machinery salesmen spend time and money trying to hone their skills, hoping to convince you that you will make more money or life will be easier if you buy their product. The same goes for software, sheet goods, hardware, the list goes on. What I don't understand is why you believe that if someone is willing to trust you with his money, that he has better advice. More than likely, if they have the business side of woodworking mastered, they will be your competitor and not wanting to give you the advice that got them where they are today.

It sounds to me like you want someone to invest in you - believe in you maybe, and help steer you to make good decisions. The steering can be found here. I have found it helpful to bounce ideas off of other guys, and value their perspective. Another set of eyes can fine tune an idea or help me see pitfalls. Networking is a great thing. One thing that I see that you have going for you is that you listen well and digest the information.

From contributor M:
Your ideas for a line of credit or investor will only be temporary solutions to your cash flow issues. Until you know your cost of doing business and charge accordingly, cash flow and profit will always be a problem. A friend of mine told me 4 years ago, "When you charge the right price, all of the other problems will go away.” I took his statement to heart and cash flow is very low on my list of problems.