Cash conversation

Cash flow is often perceived as being pure mathematics – money in versus money out.

Yet, finding an equilibrium between bills due and fees owed is more complex than the numbers on a balance sheet. While effective management systems are important, so is clear communication with clients about payment expectations.

A 2016 report from accounting advisory Business Fitness shows the average debtor days of Australian SME accounting firms is 54 days, well above the standard 30-day trade terms. In the rush to put clients’ first, some accounting practices are putting their business’ needs last, a strategy that can undermine the business’ success.

Following the flow

Cash flow as a concept is fairly simple. Cash must be paid into a business at a rate that allows cash to be paid out to suppliers and staff.

If cash flow is not properly managed, a business will face due dates without the necessary liquidity to pay. Over time, this can decrease a business’ working capital, according to Atradius Australia’s managing director Mark Hoppe.

“If you’re getting paid more slowly than you have to pay money out, that eats into your cash,” he warns.

To quantify their activity, accountants often point to revenue. Yet, billing clients does not translate to business success if money is not coming in at necessary intervals, Mr Hoppe says.

“It’s okay to have a nice result on paper, but in the end, you need to have positive cash flow in the business, even more so in an SME.”

QuickFee’s managing director Bruce Coombes agrees, saying revenue is “of no value until you can bank it”.

The consequences of falling into negative cash flow can be severe, according to Mr Hoppe. The business may need to deplete its cash account or take out borrowings to pay its bills. Suppliers who are not paid on time may withhold goods, leaving the practice without the resources it needs.

Struggling to make payments also leaves the practice with fewer resources to develop or expand its services, Mr Coombes warns. If the problem is exacerbated, businesses may struggle to pay their taxation or superannuation obligations. They may also struggle to pay shareholder dividends.

“In an extreme case, a firm may not be able to continue if it’s not getting paid,” Mr Coombes says, adding, “Money is a finite resource”.

First Class Financial Group’s executive director Clive Barrett takes the warning one step further, urging accountants to see cash flow as a core business focus.

“The major reason most businesses fail is as a result of not having sufficient cash flow,” he says.

Potential pitfalls

Despite accountants’ solid understanding of financials, their practices face numerous challenges to maintaining a healthy cash balance.

Some of these challenges are operational. The nature of an accountant’s service means they often only bill clients once or twice a year. Given the fact that most suppliers tend to bill on a 30-day cycle, a practice can be left paying bills without a regular inflow, Mr Coombes says.

“A lot of the time, SMEs engage their accountants maybe once or twice a year, whereas a lot of other interactions with their own suppliers and customers can be regular, weekly or monthly, interactions,” he says.

SMEs also tend to have less of a buffer to cope with late or non-payment. According to Mr Hoppe, small practices are less likely to have hard assets and may struggle to secure borrowings.

“There’s more room for error overall [with SMEs],” he says.

Small accountancy practices are also disadvantaged due to their position in the supply chain. Their suppliers tend to be larger businesses that expect payment on time and can withhold goods or services if payments are late.

At the same time, accountants find it difficult to withhold services from clients for non-payment given the large intervals between client meetings.

“Even though [accountants] are getting paid more slowly, they have to pay their bills more quickly,” Mr Hoppe says, adding, “So all of a sudden there’s a hole in the cash flow.”

In addition, accountants face less tangible challenges such as client relationships. Even when a client has failed to pay on schedule, most accountants are reluctant to raise the issue immediately.

“Accountancy firms are less likely to stop providing the service because they want to keep the relationship,” Mr Hoppe says.

Mr Coombes believes this reluctance stems from a natural tendency for accountants to put their clients first.

“Accountants, on the whole, will put their clients ahead of themselves,” he says.

“As a result, they are less inclined to have a conflict-style conversation with a client when they feel that the clients’ interests might be impacted.”

Even where accountants have made their payment terms clear upfront, they may be reluctant to enforce payment if they are aware the client is struggling financially.

“Accountants often know the client’s financial position and think they can help their clients get out of their difficult situation,” Mr Coombes says.

“But the accountant needs to remember they are running a business and they need to get paid as well.”

Re-aligning the cycle

When an accountant finds their practice consistently falling short on cash reserves, they may need to reconsider how their cash flow is managed.

Mr Barrett suggests accounting firms look at how their clients are being billed. Sending invoices immediately after a client meeting is likely to result in receivables coming in more quickly, he says. He also recommends offering clients a settlement discount if they pay before a set date.

Mr Coombes also weighed in, warning that the longer a bill is outstanding, the less likely it will be paid. Sending bills out straightaway – and following up with regular reminders – will compel a client to prioritise paying.

“If the accountant is not pushing, the client is not going to volunteer to pay earlier,” he says.

Having an overview of incomings and outgoings is critical and may highlight where the gaps in cash flow are.

“If they’re paying their bills on an average of 30 days, they need to make sure they’re billing their clients on a 14- or 21- or 30-day period,” Mr Hoppe says.

In situations where clients only come in once or twice a year, he recommends staggering bills to ensure that one client is paying in January, another in February and so on.

However, Mr Hoppe warns that cash flow management is not a ‘set and forget’ procedure. Accountants should be reviewing their cash flow on a regular basis.

“It’s about making sure you’re doing good forecasting and staying on top of your cash flow, rather than just taking a look at it once a quarter or once every six months,” he says.

Numerous technological options are available to help accountants manage their incomings and outgoings, according to Mr Barrett.

“There are many accounting software companies that provide this technology,” he says.

These systems can allow accountants to track debts, send automated follow-ups and forecast future patterns.

However, Mr Hoppe warns that technology alone is not enough.

“The software package is one thing, but it’s about keeping on top of it and managing the relationship with the client.

“You still need the discipline yourself, no matter how good the package is.”

Discipline may mean forcing yourself to have a potentially uncomfortable conversation with your client about late payments.

Mr Coombes believes cash flow does not come down to numbers but to human relationships. A willingness to communicate openly with the client about payment terms is the best way to avoid non-payment.

Accountants should be discussing payment plans with the client in the first meeting.

“The number one tip is to have a conversation with the client right upfront,” he says.

“Work out right at the start of the engagement what payment method is going to work for the client. Is it 50 per cent or 100 per cent upfront? Do they agree to pay in full?”

These conversations set an expectation that the accountant will be paid on time for the work they do. They also establish any potential barriers. Mr Coombes advises accountants to view the conversation in the same way a bank assesses a candidate for a loan. What is the likelihood the client will be able to pay on schedule?

Back-up options

Even the most diligent business owner may run into a cash shortfall. An unexpected bill comes in, a client’s business goes bankrupt or an investment fails to pay dividends and the accountant is suddenly facing a hole in their cash flow projection.

To prevent this from getting the accountant behind on their own bills, practices should hold sufficient cash reserves and avoid unnecessarily tying up cash assets, Mr Barrett suggests.

However, large cash reserves are not always feasible for small businesses with limited margins and in these cases, businesses may benefit from an overdraft facility at their bank.

“An overdraft is basically a short-term business loan, just a rolling one. It’s almost like a credit card,” Mr Hoppe says.

“If they have to pay bills, they can draw on that [lending pool] and as they get paid on their own bills, it clears the account.”

Similarly, short-term business loans may help businesses plug temporary gaps in their cash flow.

While these solutions do work, Mr Hoppe advises businesses against relying heavily on borrowings. If a client fails to pay, a business is still liable to repay the loan or overdraft.

“If you can afford to pay it, that’s fine. But if you’re relying on payments coming in from your customers, what happens if those customers don’t pay?”

Using borrowings to pay operating expenses can also leave a business continuously scrambling to repay loans, limiting its growth opportunities.

“As a business owner, you’d rather be borrowing to grow your business, not just to sustain your business,” Mr Hoppe says.

“If you’re borrowing to increase the size of your business, that’s great. But if you’re borrowing to play catch-up, you need to look at why that’s happening.”

An alternative option is debtor financing arrangements, where a non-bank lender covers the company’s outstanding invoices, Mr Barrett suggests.

“Having the ability to generate funding from invoice or debtor funding has allowed many companies to dramatically improve their cash flow,” he says.

Under such arrangements, including those offered by Mr Coombes’ firm QuickFee, the lender pays the client’s outstanding invoices and the client pays back the lender. Mr Coombes says this can help the accountant get paid faster while allowing the client more time.

However, clients may incur a fee when using a debtor-financing service and some accountants could prefer to keep their payment relationships in-house.

Another option is credit insurance, which pays out if a party in a transaction goes bankrupt before the final bill is paid. Mr Hoppe’s company Atradius provides cover for B2B transactions, offering accounting firms protection if their clients are other small businesses.

“If I’m an accountant providing services to a business and that business goes bankrupt, unless you have some sort of insurance, you’ve lost that cash,” he says.

“But you can take out insurance that puts the cash back in your business.”

Alternatively, accountants may choose to make a provision for bad debt in their profit and loss statement, allowing the business to incorporate non-payment into its forecasts.

Mr Coombes believes accountants overall are becoming better at managing their cash flow. The Business Fitness study showed that accounting firms in Australia have reduced their cash lock-up by 13.4 per cent in the past two years.

When examining cash flow within a practice, the most crucial lesson may be that clear communication makes non-payment less of a concern.

“Successful firms are the ones that are not scared to have those conversations with their clients early,” Mr Coombes says.