SOLVING CASH FLOW PROBLEMS

Oct 1, 1997 12:00 PM, Vincent Mallardi

As if any manager hasn't noticed, the printing industry is short of cash!

In fact, ours is the worst among all 20 sectors of the U.S. economy in terms of cash flow and earnings before depreciation, interest and taxes. How we deal with this problem certainly is an important operational task.

What exactly is cash flow? In its simplest terms, cash flow is the amount of net-cash inflow over outflow that a business generates each month. This is not net sales but, rather, actual monies received in connection with sales. This amount is not reduced by costs but by actual cash payments. Further, it may be increased by any conversion of assets to, or liabilities from, cash.

The problem is that printers don't collect cash fast enough and end up paying too much for the consequences of inadequate cash flow.

For example, according to the Printing Industries of America (PIA) Ratio Studies, the "average" small printer earns 2.4 percent on annual sales after deducting one percent of these sales for income tax, seven percent for depreciation and 12 percent for interest. Two cash flow problems are evident: The depreciation shield is too small, and there is too much borrowing to make up for slow collections. In fact the average plant is 14 years old and 68 days outstanding on receivables. If both were halved, cash flow would double.

Let's start with fixed-asset turnover. Printers hold their equipment and real estate longer than any other industry, resulting in depreciation rates that neither cover replacement nor inflation.

One possible solution to this problem is an asset swap, a practice that is common outside the U.S. It works best when one firm is liquidating to become a printing brokerage or specialize in another manufacturing category but needs the benefit of the swapped item.

Here's how the asset swap works. A seven-year-old sheet-fed press, on the books for $300,000, after straight-line depreciation at $100,000 per year, is exchanged for a three-year-old model at a premium value of $900,000. The difference is paid in the form of a secured trade credit to the dealer in the amount of $600,000. The company increases its assets and liabilities equally, plus its cash flows, by having the unearned income offset to earnings and the discounted value of four years' additional depreciation.

Both get step-ups in value without tax consequences. The dealer, if selling to an offshore buyer, also obtains a tax credit under the export trading and foreign sales provisions of the Internal Revenue Code. A disclaimer is in order, however. Do not try this yourself--consult a tax professional!

Easier to calculate is the reduction of average days outstanding (ADO) of receivables. This is the most unproductive and typically the largest "asset" in our business. There are several ways to reduce ADO, but the best strategy is to require cash up-front and/or an assignment of the invoice.

Paper is a low markup item, and often constitutes a quarter or more of a total job. Prepayment of paper can substantially improve cash flows and timing while reducing down-the-road non-payment risks. Consider making prepayment of paper a standard practice.

Bad debts, now approaching five percent of print sales, can be eliminated through assignments via factoring or trade acceptances that, on average, charge between three percent and four percent. Professionally handled credit and collections eliminate customer negotiating leverage.

Frances Zelanzy, with New York City-based Actrade, a provider of trade acceptances, claims that printers can increase profits by outsourcing credit. "Your business is products, not money-lending," says Zelanzy. "So get an expert to handle everything to do with credit and collection."

Zelanzy describes a Long Island trade shop's successful use of trade acceptances that doubled cash flow, lowered operating costs and reduced bad debts by $150,000. When a job is placed, the customer fills out a credit application for approval by the credit outsourcer and then agrees to specific payment dates.

The agreement takes the form of post-dated promissory notes with reasonable interest that remove the seller from the collection process. The job is paid for by the outsource provider at acceptance of delivery. The procedure differs from factoring, which is seller, rather than buyer financing.

"Trade acceptances provide a new selling tool," claims Dan Mauriello, vice president at Jalor Color Process (New York City). "Customers can receive up to five-month terms on installments for work completed." He cites catalog, direct mail and broker clients as those most desirous of this flexibility. "The beauty of it is we choose the customers to whom we offer this feature. It just makes the sale more attractive."

Freed-up cash is "king" when it's employed for trade discounts among suppliers. Prepress houses, binders, finishers, mailers, truckers and other labor-intensive subcontractors can benefit and therefore offer discounts of five percent to 10 percent for a win-win transaction.

In addition, such discounts are offered when there's guarantee of payment by a third party. Ignacio Hernandez of Capital Bank, one large commercial factor, explains.

"A reputable factoring relationship may include letters of credit to vendors secured so that the cost of the discount is a small fraction against what is saved. In other words, certainty of payment has a value that buyers shouldn't ignore."

This principle is practiced by astute purchasing pros who also leverage their buys through corporate purchasing accounts with American Express, Visa and Master Card. Here's how it works. If a vendor agrees to sign up, conceding cash for payment on day of delivery, the buyer will electronically transact through its corporate card. Purchase orders, credit checks and payment checks are eliminated. Since nearly all Fortune 500 companies will be signed on to this program within the next several months, it may be good idea for other organizations to get into the loop.

Yet another option is for small customers to use "plastic" in combination with minimum order policies to help raise fast cash. Simply establish, for example, a $1,000 minimum for billing terms, or otherwise charge to a credit or debit card. With a card guarantee, payment also may be timed on installments with handling charge added.

Cash flow mismanagement is certainly the biggest contributor to business failure, aided by flawed accounting methods. Machinery, depreciating but producing linearly, gives the impression of annually improving return-on-assets.

This distortion, which overstates earnings on older assets while understating them on newer ones, is corrected with the annuity method of depreciation. This method considers the time value of money and imputes an interest-income based on the size of the unrecovered investment, subtracting it from the depreciation expense.

Current asset turnover, in which the ratio of cost of goods sold and expenses is calculated in relation to current assets, also should be adopted. As with fixed assets, the greater the turnover, the more liquid and profitable the enterprise. The first investment in cashing out of the cashflow crunch is participation in the PIA Ratio Studies. Then start turning over assets to turn profits that can easily double.

* Speed up cash inflows with deposits, CODs, charge cards, trade acceptances and factoring * Reduce cash outflows via tradeouts/barter assignments, and always taking cash discounts * Turn over fixed assets through swaps and pooling arrangements that step up depreciation shields * Eliminate bad debts by tightening credit and placing receivables promptly for collection