Case studies take us beyond theory, and into practical application. For that reason, they are a great vehicle to share information with readers.
This post focuses on managing rapid employee growth in a service-based business, a problem common to many service-based businesses.
Let’s take a look at the challenge faced by one of my clients, and the solutions we created in response.
Client: Service-based business
An engineering firm, whose employees are paid on salary and client work is typically based on contracts that average six to twelve months in length.
Challenge: Cash Flow
Because income doesn’t come in the door until consulting work is contracted and billed – and eventually paid for – incoming cash is irregular. Yet, outgoing cash demands for payroll, rent, and other operating expenses are regular and fixed.
Cash-flow issues were compounded for this company as a result of rapid employee growth in the past year.
Solution: CFO action
I’ve been in business for over 30 years, and typically my debt levels increased as we experienced rapid growth. This is the first time ever that we are actually decreasing debt and growing rapidly at the same time. – CEO
Four critical actions which, when used in concert, create opportunities for this client to manage their cash flow – and their business – more effectively.
1. Evaluating expenses
With a business model relying on irregular cash flow, management needed to understand the need for lowering overhead costs.
First, we identified all unnecessary or non-critical expenses. Next, we identified software and services that were going unused and cancelled those subscriptions. We then set budgets for office meals and clearly communicated those budgets to the budget owners in the business (i.e. the office manager in charge of office supplies and kitchen items).
These simple changes made an immediate positive impact and have helped ease the cash flow burden. Equally importantly, they created a mind shift for management.
2. Accelerating A/R (accounts receivable)
Before we intervened, the company typically received payment for their work 45-60 days after the end of the month in which the work was completed.
A new process was introduced, allowing the firm to bill clients 1 to 5 days after month-end. All invoices indicate that invoices are due in 30 days.
While the firm doesn’t have control over how quickly the client pays them, they now have the ability to track outstanding invoices via Quickbooks Online and to follow up quickly when payment is not received when expected. A review of accounts receivable is done regularly to track payments that are late and outstanding invoices are followed-up on in a timely manner.
3. Improving predictions
In service-based business with salaried employees, it’s fairly easy to predict future labor costs – particularly if there are few changes in the business. When that’s the case, past costs can be a good indicator of future costs.
When you have contract employees – or when you need to grow your salaried and/or contract employee base due to business growth – it’s more difficult to make useful predictions.
In this situation, we created a “Cost to Hire” financial modeling tool. This powerful solution allows the firm to factor in all costs associated with a new hire – from salary, taxes, and benefits to furniture, equipment, dues, subscriptions, and more. With this tool in hand, the firm is far better equipped to accurately estimate the wisdom of bringing on additional employees at any given point in time.
4. Projecting Salary-related Cash Flow
To most effectively manage the changes made and the estimates available, we created a “Cash Flow Worksheet”, combining information from:
- Current bank balances
- Expected incoming cash from consulting contracts
- Anticipated business costs
- “Cost to Hire” tool (see the end of the post to get your copy)
With this data, the firm can now estimate the incremental monthly cost of a new hire. This allows us to determine optimal start dates for new employees, and how new employees will affect cash flow.
The processes and solutions we created for this firm allowed their CEO to answer key questions, such as:
- “Can I afford to hire this person given my current cash situation?”
- “What is their optimal start date from a cash-flow perspective?”
- “Can I afford to pay them competitively?”
In addition, new metrics allowed the CEO to clearly identify the point at which operating cash would be in the “danger zone”, and to make adjustments as needed. This could involve accessing savings or a business loan or line of credit. Additionally, he also knows how much business he needs to bring in to cover expenses and reach his profit goals.
Finally, the CEO now understands the ongoing costs of the business decisions he is making now. Armed with this information, he better understands how much additional contract work needs to be brought in – not only to cover costs, but also to hit profit targets.