The oil and gas industry is known for being somewhat unpredictable. Demand for products and services can change quickly with little if any notice. Actually, sudden increases or increases in supply and demand are not uncommon. These drastic changes create financial hardships for small oilfield service companies.
This article discusses three strategies to help improve your cash flow. This information enables your company to adapt to changes faster and capitalize on new opportunities more effectively. We cover:
- Common cash flow problems
- Are your billing and collections working well?
- Early payment discounts
- Financing options
1. Cash flow problems
Several situations can cause a small oilfield service company to get into cash flow problems. However, most of these situations originate from a common source: slow client payments.
In most commercial transactions, oilfield service companies have to provide their product/service and wait net-30 to net-60 days to get paid. However, the company often has to pay its expenses before getting paid by the client. These expenses include payroll, equipment, rent, suppliers.
This situation creates problems if your company doesn’t have a cash reserve, has collection issues, or is growing very quickly. We cover a simple and methodical approach to solving these problems in the following sections.
2. Are your billing and collections working well?
If you have cash flow problems, first examine your invoicing and collections. Are you invoicing your clients promptly? Then, look at client payments. Are many of your invoices beyond terms? This information helps you determine if your invoicing and collections are working well.
Improving your billing and collections is simple but requires discipline. Consistency is key. The following approach has worked well for many companies:
- Check the business credit of your client. Work only with clients who have good commercial credit
- Have the client sign off on the work or product delivery
- Invoice promptly. Include all required paperwork, including a copy of the sign-off sheet
- Follow-up to confirm the client received the invoice
- If payment is late, call to inquire if everything is OK
- Always be polite and professional
- Enlist a collections attorney if the client won’t pay in a reasonable timeframe
To learn more, read “The Best Way to Collect Unpaid Invoices.” If you still have financial problems after improving your invoicing and collections, the next step is to use early payment discounts.
3. Early payment discounts
A common way to get clients to pay faster is to offer them an early payment discount. As its name implies, the strategy involves providing clients with a 1% to 2% discount if they pay the invoice early within ten days. If they pay after ten days, the client pays the full price.
It’s best to offer this incentive to customers with good business credit. Offering this incentive to clients with a bad payment record can worsen a bad situation.
Examine your profit margins to ensure the company’s profit margins support offering the discount. Oilfield service companies that operate in low-profit margin services/products should not use this option.
Lastly, keep in mind that an early payment discount is only a client incentive. Clients may choose to use it or not. It’s not unusual for customers to stop paying early during difficult economic times, just when you need the quick payments the most.
If improving your invoicing and offering early payment discounts does not fix your cash flow problem, consider using financing.
4. Financing options
Cash flow problems related to slow-paying clients can be improved with accounts receivable (A/R) financing. Two solutions work well for small companies: invoice factoring and sales ledger financing. Both are easier to obtain than bank financing and are well-suited for small and growing companies.
a) Invoice factoring
Invoice factoring allows you to sell your invoices to a factoring company in exchange for immediate payment. This payment provides your company with the funds it needs to pay suppliers, employees, and other expenses.
This solution works well for growing oilfield service companies with monthly revenues under $200,000. It’s commonly used by transportation companies that serve the energy industry. The qualification requirements are fairly simple. Your:
- Clients must have good commercial credit
- A/R must not be encumbered by liens
- Management team must be experienced
For more information, read “What is Invoice Factoring?” and “How Does Invoice Factoring Work?”
b) Sales ledger financing
Companies that invoice more than $200,000 per month can consider sales ledger financing. Sales ledger financing works best for companies with a well-organized invoicing and collections department.
The solution resembles a line of credit that is secured by your accounts receivable. Your company can get funds up to a credit limit that adapts as you issue new invoices and clients pay old ones. It has a number of advantages over other solutions and works well with small and growing companies.
5. Which solution is best for you?
The best strategy for most small and midsize oilfield companies is to use a gradual approach. Ensure that your billing and collections work efficiently. Then, implement early payment discounts only if needed. Consider using financing if the previous options don’t meet your needs. Smaller companies should consider invoice factoring, while larger companies should consider sales ledger financing.
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