IKEA

How do you get out of a cash-flow crunch?

December 17, 2013: 5:00 AM ET

Skip the obvious solutions and try a financing source most businesses ignore.

By Verne Harnish

Close-up of coins falling on a person's hands

FORTUNE -- When money is tight, turning to your best customers is often the smartest way to get cash flowing again. Look for ways to get customers to pay you up front for the things they are planning to buy in the coming 12 months, ideally for a whole year's worth of products or services at once. Even if you have to offer them a discount to pay ahead of time, it beats taking out a high-interest loan, which may be your only other option in today's tight lending climate.

Yes, it sounds crazy, but don't talk yourself out of this approach before you try it. Successful entrepreneurs do well because they're willing to ask for things that others won't.

I know this strategy works because I've been in this situation. My business suddenly lost a bunch of revenue overnight after 9/11. I asked 17 of my best customers to advance what they would spend with me that year, and they said yes. In return, I let them lock in that year's prices.

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Meanwhile, take a close look at how you're managing cash flow so this doesn't happen again. The first entrepreneurial law of gravity is that growth sucks cash. It's easy to run out of money if you're doubling or tripling sales year over year. (If you haven't already read the 2001 Harvard Business Review article on the subject, you should.)

Cash is so critical that you should pay attention to it every day. Have your CFO or bookkeeper report on how much cash you have in the bank every morning -- with a brief explanation for what came in and came out in the last 24 hours -- and what's expected to come in and out over the next month. Online banking makes this very easy. If you're not paying attention to your accounts receivable and accounts payable every 24 hours, it's easy for trouble to sneak up on you. Getting daily reports on your cash flow can teach you more about your business than studying your P&L statements. In my own case, I found out how much I was acting as my customers' bank.

Conditions in any industry can change in a heartbeat, so building strong cash reserves should be a top priority. One of the key lessons from Jim Collins's Great By Choice is that the most successful companies maintain 3x to 10x the ratio of cash to assets and cash to liabilities of their competitors, so they can weather storms.

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The recession after September 11 made me starkly aware that I needed more cash in reserve in my own company. During Microsoft's (MSFT) early days, Bill Gates decided that the company should keep enough money in the bank to be able to go a full year without revenue, so I followed his lead at my own company. After my 17 customers paid me in advance, I put enough cash to cover a year's worth of expenses in the bank -- and have kept it there ever since -- so I could sleep easier. Nothing ages an entrepreneur more quickly than being low on cash.

I also took a close look at my prices and realized they were too low. By raising them 25%, I increased my gross margins by 13 percentage points. Charging more enabled me to cover the cost of discounting the services I gave to those 17 customers. My customers didn't balk at the increase, and the healthier gross margins allowed us to grow. Of course, you've got to keep up your end of the bargain if you raise prices. You've got to deliver something customers don't want to do without.

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