When the operational cash flow gets tight, many business owners automatically consider external financing. Yes, external financing – debt, equity, a hybrid of the two, alternative financing – can be the answer to your business’ expansion funding or working capital needs. However, for those of you that have more stable businesses that are growing at a slower or relaxed pace, operational cash flow should be the place you look at first. Cash flow is supplied by three sources: operations, financing and investment. Use cash flow from financing sparingly unless you have the strong operational cash flow to repay the debt over the allotted period or you expect to have significant growth with which to interest and retain investors.
To free up operational cash flow, you need to examine your operations and identify areas in which your company is overspending or wasting cash. Below are some of the areas many business owners overlook.
Sales Commissions – Enron Energy Services Example
Your sales commission must be properly structured to appropriately incentivize your sales team. When I worked at Enron, Enron Energy Services (EES) had a sales commission structure that resulted in deals that were completely out of the money as soon as the deal was executed. For those of you who do not have an options background that means that Enron lost money as soon as the deal was finalized. How did this happen? The sales people who pursued and closed large energy provision deals with large industrial users of energy (EES’ target customers) were provided with commissions based purely on the size of the deal. Thus, top salespeople, of which Enron attracted the best and the brightest, closed huge multi-million dollar deals. However, EES had to pay more to deliver the service than the contract pulled in after paying commissions and other sales costs. As a result, those huge deal announcements hid the fact that EES was hemorrhaging cash as it began performing on these contracts.
Proper Sales Commission Structure
Hence, you need to have gross profit targets for your business that consider the gross profit margins of your industry. Therefore, you should tie your commission structure to a profit number – either gross or net – not to gross sales. By doing this, you ensure that your salespeople are incentivized to protect your company’s gross margins. Otherwise, you could have a scenario similar to that of Enron…or perhaps you do already.
You can establish a maximum discount rate for each product or service you offer. You could even motivate sales people to pursue higher margins by implementing a sliding scale and paying higher commissions for higher gross margins.
Second, only pay out the commissions once you receive payment from your customers. In many companies where the sales people hand off customer management to an account representative, something gets lost in the relationship transfer. The sales person had to really connect with the customer to make the sale but the account representative often does not need to connect in the same way to service the account, especially not initially. By mandating that the invoice is paid before you pay out commissions, you incentivize your sales people to remain in contact with the customer and to gently remind them to pay on time. Many salespeople hate being bill collectors with their customers so, when their commissions and bonuses are at stake, to mitigate any collection behavior they typically stress the need for prompt payment all throughout the sales cycle.
You can place time limits on customer payments. For example, if the customer pays within 30 days, the sales person gets 100% of the commission or bonus but if the customer pays within 90 days, the sales person gets 0, or a greatly reduced percentage of the sale. Of course, this means that you also need to have strong billing, credit and collection policies in place that you actually use. Otherwise, you will be placing all the onus on your sales team. This is not just unfair; it is also poor management of your finance and accounting operations.
If your business has decreased or your sales are on autopilot, you may not need the same number of “hunters” in your direct sales force as you had before. The “farmers” or account representatives, customer service representatives or whatever your business calls them may suffice. Therefore, you may want or need to consider reducing your sales staff. If so, depending on the type of business you own, you may be able to utilize manufacturer or independent representatives to sell your product for a period of time. These representatives can help you break into new industries, expand your geographical reach, or pursue very large customers more efficiently. In addition, most manufacturer representatives and independent reps work solely on commissions.
Click here to read Part II, which covers multiple locations and inventory.
Need more ideas to help you generate operational cash flow, contact us at The Resourceful CEO.