Smart Cash Flow Management for Rental Businesses

June 1, 2006
The rental business is a cash flow business. Cash is always flowing — both in and out.

Fleet is purchased, rented again and again, and then eventually sold. Employees are paid salary, bonuses, health insurance and other benefits. The building is leased, signage is purchased, office supplies are ordered, utilities are paid, and advertising is planned and bought. Sales trucks, trailers and delivery vehicles are paid for and insured. And then other inventory and maintenance supplies such as oil, transmission fluid and gasoline must be acquired to keep on hand. That is over-simplifying the cash requirements of a rental business, of course, but just that short list demonstrates the necessity of positive cash flow.

But what exactly is cash flow? There are two ways to conceptualize the term.

  1. The first is to think of cash flow as a rental business' net income with interest, income taxes, depreciation and amortization added back in (known as EBITDA).
  2. The second is to think of cash flow as the amount of true cash coming in and out of the business from day to day — just think of it as adding and subtracting from a personal checkbook.

Whether a rental operator sets a goal to maintain positive cash flow or dip into negative cash, the goal is the same — to grow the business and broaden the fleet mix and customer base.

According to Dan Kaplan, owner, Daniel Kaplan Associates, Morristown, N.J., “The rental business is a negative cash flow business in good times and a positive cash flow business in bad times.” To further explain what he means, Kaplan says that growing a business requires buying more fleet, which uses capital and depletes cash.

Conversely, when times are hard, companies reduce the purchase of equipment and immediately cash flow turns positive.

“Growing the business completely depends on your capex expenditures, acceptable rental rates and good rental terms,” he says. “When you turn off the spigot of buying equipment, then your cash flow turns positive. And when business is producing positive returns and EBITDA is good, then the business is growing, you have hard assets and your balances are in line.”

In that case, Kaplan says he sees nothing wrong with negative cash flow. In 1997 and '98 during the era of consolidation in the rental industry, analysts wanted to see positive cash flow. They saw one rental company acquiring another rental company as a good way of expansion, which, naturally, included goodwill expenditures. But the cheapest way to grow a rental business, he says, is to add fleet when the need for additional equipment is justified.

“Analysts who make these commentaries don't understand the rental business,” says Kaplan. “They want the business to grow and at the same time they want to see positive cash flow on top of it. It's not realistic.”

Kaplan's concept is comparable to the familiar saying, “It takes money to make money.” A rental company that's truly growth-oriented generally requires more fleet, which equates to more money spent on capital expenditures.

“I believe that a rental company, if they're postured for the future, needs to be spending a minimum of 20 percent of its fleet size a year on both maintenance capex and growth capex,” says Kaplan. “If they're spending less than that 20 percent then they're not providing for the future.” He suggests that spending 20 to 30 percent of total fleet size on capex is healthy spending; 30 to 32 percent is really healthy; and less than 15 percent means the company is headed in the wrong direction.

stay on track

Tracking cash flow in the rental business is essential for keeping the company in balance and evolving in the right direction. Some rental operators, however, make the mistake of only looking at financial statements once a year. And in many instances, year-end financial data isn't available until March, April or May of the following year. Being this far behind real time doesn't give rental managers a quick enough opportunity to make the necessary adjustments to avoid repetition of mistakes.

Gary Stansberry, partner in the Cameron Park, Calif., and Arlington, Texas-based consulting firm of Hageman, Stansberry & Associates, says he cannot overstate the importance of having an accurate and timely financial reporting system in place to track cash flow on a monthly basis. In addition, line items such as revenue, dollar utilization of the rental fleet, payroll, and repair and maintenance expenses are important to track on a weekly basis. Oftentimes rental operators get so busy answering the phones and doing the day-to-day business that they don't make time for this kind of detailed tracking.

“So often, all of this is in place, but it's not utilized,” Stansberry says. “Many times the software system turns into a glorified invoice-writing system. Most rental software is capable of capturing the data, but rental operators don't look at it.”

Many rental managers don't delve deeper than the top line of revenue and some expenses, Stansberry adds.

“To put it in a sports analogy: They played the game, but they don't have the final score — they don't even know what their opponent scored,” Stansberry says. “Every rental company should have a system in place to track cash flow and do trend analysis on revenues and expenses. You should be able to compare what they were this month, last month, year-to-date, this month last year and year-to-date last year.”

Making these comparisons allows the rental operator to see where variations are occurring and identify where adjustments need to be made. It also helps the operator isolate areas to watch more closely — common ones are payroll expenses and dollar utilization. Since payroll is generally the biggest chunk of cash expenses — often eating up 50 percent of a rental company's cash expenses, including salary, bonuses, health insurance and other employee benefits — Stansberry recommends that payroll consume no more than 20 to 25 percent of the business' total revenue, and no more than 30 percent of revenue for a small rental store. The second-biggest consumers of cash, Stansberry says, are repairs and maintenance, which make up between 6 to 10 percent of rental revenue.

software solution

Edward Spence, franchise business planning manager for Asheville, N.C.-based Volvo Construction Equipment Rents, developed a proprietary business model program for the company that highlights a comprehensive business plan for new Volvo franchisees that works through financial figures and provides pecuniary summaries for the first five years.

“It has the built-in ability to show somebody at a high level of financials how and what affects their business,” Spence says. They can see exactly how many different variables impact their financial data. We do a lot of training that addresses cash flow and how to do a cash flow statement as these new franchisees enter the business.”

Because utilization, like payroll, is another huge influence on cash flow, Spence's software features a built-in utilization trend chart to address seasonality issues and other “what-ifs” such as accounts receivable and interest rates. Spence calls this “sensitivity analysis.” After the appropriate variables are plugged in, the Volvo Rents program demonstrates that for every 1 percent of annualized dollar utilization, a rental business' cash flow can improve by up to $40,000. Though this is just one example based on one set of variables, it shows how significant a small improvement to dollar utilization truly is.

“It is a very comprehensive program and tool; it makes you think through every issue that you can have in running a construction equipment rental business,” says Paul Bullock, owner of Volvo Rents franchise JPS Equipment, which has branches in West Monroe and Alexandria, La. “It tracks your month-to-month cash flow and gives you projections. It lets you know ahead of time if you have a cash flow problem on the horizon, which is the beauty of the program.”

Though Volvo's software is exclusive to that company, most rental management software has a feature that specifically highlights a fleet's dollar utilization, usually piece by piece.

A rental manager may need to adjust the business' fleet mix to improve dollar utilization. In some cases a rental operation may be undercapitalized because it doesn't have a big enough asset base to pay the bills. So, how does a rental manager determine if the business has the best fleet mix to maximize utilization, and thus, cash flow? The answer is with exception reporting, which can be done easily with most rental management software.

A rental company's fleet is initially designed with several variables in mind that include:

  • seasonality trends of the business' geographic location;
  • the customer base,
  • whether it's small contractor,
  • large contractor or homeowner-based;
  • and how much cash the company can afford to pay each month toward financed equipment purchases.

But a rental fleet is an evolving commodity with equipment coming and going all the time.

Rental managers should regularly monitor the fleet on a line-by-line basis with a utilization goal of about 70 percent, meaning that the unit paid 70 percent of its original cost back to the company in one year, says Stansberry. Rental managers should look at items with 50 percent utilization or less and ask themselves, “Are rates too low? Do I have too many of a particular item in the fleet? Has a particular piece of equipment been down for repairs too long?”

Remember the four basic tenants of time and dollar utilization and review them for each item in the fleet.

1. High time and high dollar: Buy more of this item. It's frequently out on rent, and it's bringing a good rate. 2. High time and low dollar: Rates are most likely too low. The unit is frequently on rent; it can probably draw a higher rate. 3. Low time and low dollar: Sell! This is a lose/lose situation. The unit is probably costing more money to keep in the fleet than it's bringing in. Take action quickly. 4. Low time and high dollar: Rates are probably too high. The unit doesn't go out as often, but when it does it's drawing a high rate. It may be out five days a month at $100 a day, but if the rate was lowered to $75 a day, it might rent for 15 days a month. Equipment that falls into this category may just be seasonal.

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x factors

It's still important for rental operators to follow the demand of their customers, but monitoring exception reports will make it easy to identify which equipment is performing well and which equipment is underperforming.

Just about everything in the rental business affects cash flow, from fuel costs to customer relationships. Nothing can be taken lightly because every decision counts.

Customer perception of the rental fleet is an important consideration that affects cash flow. If a fleet contains items that are chronic maintenance problems, is it a good idea to continue to put those items on rent? Anything that requires repair and maintenance that costs more than 10 percent of revenue should be looked at closely, Stansberry says. It might be best to sell that equipment and reinvest the capital in a more reliable machine.

Rental managers can also talk to mechanics regularly to find out which pieces are workhorses and which ones are lemons. Equipment age isn't always the best determining factor in deciding what units to dispose of. A fleet may have a 6- or 7-year-old backhoe that runs great and is always reliable, but a late-model backhoe that's typically in a service bay, draining the business' cash.

Counter personnel also have an influence on which items are renting and which are sitting on the yard. Many times the counter person will rent out a newer machine before an older one because they don't want to get the call that it's broken down on the jobsite, Spence explains. So to avoid the potential hassle with the older machine it just sits on the yard not being utilized at all, again negatively impacting the business' cash flow. Managers should communicate with employees behind the counter to avoid creating these low time/low dollar machines.

“Take a look at it and if it's not going to get any better in value, then take your lick and move on,” Spence says.

Maintaining a lost rental log at the counter that records when and why a rental was lost will help the rental operator better serve customers in the future. A log entry should be recorded each time the company gets a call for a piece of equipment that isn't on hand, whether it's because the item isn't part of the fleet at all or whether it's already out on rent; when a rental is lost because the rate was considered too high; and when an item that is part of the fleet doesn't match the customer's needs. After awhile the rental manager will start to notice trends that will be useful the next time equipment is purchased.

Increases in fuel costs and insurance rates will also have a direct impact on cash flow. Rental operators should adjust delivery and pick-up fees frequently to account for rising prices.

“It is especially important right now to be constantly checking,” says Stansberry. “If you're charging the same rates you were two years ago, then you're losing money.”

In addition, be cautious about making equipment purchases based on upcoming construction jobs in the area, Stansberry says. These jobs are usually highly competitive among rental companies and rates are often driven below what they should be. When the economy is good, small and medium-sized rental companies are sometimes better off not having a bunch of their equipment in one place at lower-than-normal rates. Instead, these small and medium companies can do very well being the No. 2 rental company on the list.

“If they need a skid-steer loader on the fly, you can service them quickly and fill in the blanks on other supplies,” says Stansberry. “There will be no haggling on the price because they need it quickly and they're willing to pay for quick service.”

One rental operator offered his company as a back-up supplier on a recent big construction project where the contractor decided to use a wholesaler in a city about 60 miles away to get supplies such as blades and other concrete materials at a discount. The rental operator, located just five miles from the jobsite, told the contractor to come to him when he needed something in a hurry or just to fill in some holes. He assured the contractor he would have those items in stock when the need arose.

collect, collect, collect

“He made a good profit off that job, just from putting himself out there as the backup,” says Stansberry. “The economy is good right now, so rental companies can benefit from keeping themselves broad and concentrating on the ongoing construction activity in their area.”

Michael Kneeland, executive vice president of operations for Greenwich, Conn.-based United Rentals, also spoke of chasing the big construction jobs. He suggests that rental operators stand back and try to understand where they are in their business cycle. Is there enough growth potential to sustain a fleet purchase after that big job is completed?

“You should not buy equipment just for one job or project,” he says. “Make sure that you have the means to support that fleet for the long term. You don't want to add fleet just for the sake of adding fleet to meet the needs of one project. Instead, understand your complete cycle and make purchasing decisions to broaden your customer base and better meet the needs of those customers.”

A surefire way for a rental company to have less cash flow coming in than it should is to ignore outstanding account balances.

determine the cash flow bulls-eye

“Pay attention to the collection process,” says Kneeland. “Discuss billing questions before they become issues. If the discrepancy isn't dealt with quickly, it will age your collection time and you won't have as much cash coming in as you should.”

Rental managers should run weekly reports and make a note of those accounts that are 60 days, 90 days and 120 days past due. “You wouldn't stand for it if your employer told you he couldn't pay you this week, that you'll get your paycheck next week, and rental companies shouldn't stand for it either,” Stansberry asserts.

team up with suppliers

According to Spence, having someone working for the business who can collect on receivables and improve your Days Sales Outstanding, or DSO, provides a huge advantage because it has such a significant impact on cash flow. Just following an example with Spence on the Volvo Rents software shows that a good collections person can swing cash flow by more than $100,000 in one direction. In fact, the software also demonstrates that it is even worth it to pay that person a little extra in salary and bonuses if they do a good job — cash flow is still better than it would be without the successful collections of the accounts receivable manager.

Establishing a healthy target cash flow is unique for every rental business depending on both the product mix and the customer base, but Stansberry offers a guideline of 30 percent of total revenue for a small, single location rental business that primarily serves homeowners and small contractors. A larger, national profile company with a delivery-based business that specializes in larger equipment should aim for a target cash flow that is 40 percent of total revenue.

Spence has what he calls the 50/50 rule: “If you are properly capitalized and your dollar utilization is above 50 percent and your DSO is less than 50 days, then you are where you want to be. Now, the business has to be properly capitalized for this to be true. You can't do $3 million worth of business with $1 million worth of fleet.” But closely tracking revenue, dollar and time utilization, payroll, rental rates, maintenance and repair costs, and fleet mix will show rental operators what variables impact their cash flow and what changes they can make to improve it and grow the business.

Rental operators can free up cash flow by working out special equipment financing and purchase deals with their suppliers.

When purchasing new fleet, rental operators can work with their suppliers to create special deals that will increase their cash flow in the near term. In good financial times or bad it's important to avoid being married to a particular brand of equipment or a particular lender, says Gary Stansberry, partner in the consulting firm of Hageman, Stansberry & Associates.

“Even in today's times, when the economy is good, manufacturers and lenders are still looking for incremental business, it's all the more reason to shop around and negotiate prices and interest rates.”

Manufacturers generally have special finance terms and lower percent interest on some equipment and also special lease deals. Finance companies are often hungry for new business, so they will likely be willing to work with rental equipment businesses. “Don't get stuck in the same rut,” Stansberry warns. “Get the best price and terms on equipment and finance deals that you can negotiate.”

According to Edward Spence, franchise business planning manager for Volvo Construction Equipment Rents, interest rates are strongly affecting the rental industry right now. His software shows franchisees the effect of several variables of interest rates, which allows the rental manager to see how his or her cash flow will be impacted as interest rates rise. Though nothing can be done about rising interest rates beyond savvy deal negotiating, rental operators can plan for and work around their impact.

“You can't control the interest rates, so you have to manage around them,” says Spence. “Know how much certain increases are going to cost you and then increase dollar utilization to make up the difference. For example, if you increase dollar utilization by 2 ½ points, then you need a 5-percent rate hike to offset the increased interest rate.”

The good news about interest rates is that it's actually a much bigger hit to a rental business' cash flow to not collect its account receivables than it is to worry about the impact of interest rates, Spence says.

Suppliers also offer special programs to rental equipment companies that may want to add some additional fleet for a big upcoming construction project, but that don't want to fully commit to purchasing those items. Some dealers offer a rental purchase option that allows the rental company to pay a pre-set amount each month for a new piece of equipment and then, if the utilization isn't there, the rental company can simply turn the unit back in to the dealer with no purchase commitment.

Rental purchase options usually have terms of either three, six, nine or 12 months. Though there are usually terms and conditions that apply, these allow rental companies to put a new piece of equipment on the yard to find out if the demand is there with much less risk than a regular purchase.

Even better than the rental purchase option is the rental split. This program allows the manufacturer or dealer to put a piece of equipment on rent at a rental company, and with each rental, that manufacturer or dealer gets 80 percent of the rental revenue and the operator gets the other 20 percent. The dealer's 80 percent goes toward the principal cost of that machine, so if a rental company gets a $50,000 reach forklift on rental split terms, every time it goes out on rent the dealer puts his 80 percent revenue from the rental toward the $50,000 purchase price.

“The reality is that you may be able to negotiate a lower purchase price if you do the deal on a cash basis, or even finance it,” says Stansberry. “In other words, you may pay more in total for the machine, but sometimes it's worth it to be able to turn it back in if the demand isn't there. You're paying a premium for your flexibility, but oftentimes it's worth it. At least you're not stuck with a machine sitting on your yard that's being way under-utilized.”

In addition, rental operators should work with vendors in advance of equipment purchases so that they are aware of which products currently have long lead times. Plan ahead to match new equipment delivery with seasonalities, suggests Michael Kneeland, executive vice president of operations for United Rentals.

“Rental managers should have an understanding with where they are in regard to seasonal trends in the area. Time your deliveries as your demand is beginning to increase,” he says.

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