Article by Herb Kimble
The expansion of your business and an increase in sales can generate more profitability but can also lead to a liquidity problem when sales are not converted into cash quickly enough to meet payroll deadlines, or pay vendors when their invoices are due. In order to expand and increase your sales you may have had to increase your purchases of materials for production, or inventory of merchandise for sale, or you may have incurred greater expenses for labor, supplies, energy and fuel, commissions, and advertising.
When payroll and tax deadlines, and the due dates on invoices from your vendors come before you have collected on the accounts receivable from your customers, you could have a temporary cash flow crisis. You may be able to get through this crisis by using the forms of financing your business has available, but financing carries a cost. Instead of going into debt to keep your business solvent, you can plan and improve your cash flow.
Collections on Trade Accounts Receivable
It is important to send your invoices as soon as your ship an order or complete the service requested. The customer or client will not pay your invoices until 30, 60 or 90 days after receiving them, many times regardless of the due date you indicate on the invoice. So each day that you delay in sending an invoice is one more day you will have to wait to receive payment.
You should facilitate the means by which your customers or clients can pay you. They are accustomed to having various payment options for the goods and services they purchase, including bank transfers, and debit and credit cards. When you restrict the form of payment to only cash or check, you are hurting the competitiveness of your business.
Establishing a merchant account with credit card companies has a cost in terms of the charges for each type of credit or debt card accepted. But these charges should be accepted as a cost of doing business in today’s market. If customers find that in your business they cannot use the debit and credit cards they use in other businesses, they might go elsewhere instead of buying from you. Establishing a merchant account is easier than it used to be, since there is a lot of competition among banks and financial service companies to offer this service.
When your business has a website, you could consider offering a service to receive payments on line. It is relatively simple to set up an account and enable your business to receive payments by debit and credit card, electronic checks, and bank transfers.
One of the key aspects in collections is to understand the policies of your customer’s accounts payable department. When you know how they review invoices and their criteria for approving invoices for payment, you can meet all their requirements right away, and thereby speed up the process. For example, when the customer requires that a copy of the purchase order be attached to the invoice, or that the purchase order number be indicated as a reference on the invoice, by meeting this requirement you can avoid the delays that occur when the customer has to request this information, or simply doesn’t pay the invoice because it doesn’t meet their requirements.
Having a contact in your customers’ accounts payable departments will provide you a means of resolving any issues more quickly. Many times when there is some discrepancy on an invoice, the customer will not take any action until it receives an amended invoice, an explanation of the charges, or supporting documentation. The invoice will simply remain pending, and if you are not aware of the problem, payment will be delayed. But if you have a friend in the accounts payable department, you can receive more timely notice of the problem and resolve it before the due date for payment.
You need to follow-up on collections. You should not count on the customer paying an invoice when it is due. If the terms are 30 days, you should call the customer on day 31 if you have not received payment. And when you have a friend in the accounts payable department, you can call to find out when the invoice is scheduled for payment.
When invoices remain outstanding 60 to 90 days or more past their due date, it is especially difficult to collect on them. Here it is important to maintain a dialogue with the customer and try to agree to a payment plan the customer can meet. Many times it is better to accept a partial payment than have to sue the customer, with the associated legal costs.
You should take advantage of the payment terms vendors grant you. If the terms are 30 days, you should schedule payment for 30 days and not sooner, unless you can take advantage of a discount for prompt payment.
When the customer offers a prompt payment discount, you can calculate the return it means by using the following formula:
Discount x 365 / difference in the number of days for payment = return on your money
For example, of payment conditions are normally 30 days and the vendor offers a 2% discount for payment within 10 days, the return would be calculated as:
2% x 365 / (30 – 10) = 36.5% a year
In the case of accounts payable, it is important to get to know your vendors’ credit managers and find out from them what they need in order to keep your payment terms attractive. Even though it is beneficial to take maximum advantage of the payment terms, you do not want late payments to have an adverse effect on your credit conditions. For example, if after repeated late payments the credit manager applies cash payment terms instead of 30 days for your account, your cash flow will be severely restricted and you could even lose your ability to purchase from that vendor, which could impede your operation when the products you buy from that vendor are crucial for your business.
If you cannot make payments to vendors on time, it is important to communicate with them as soon as possible. They may be willing to accept a situation in which your payments are going to be a few days late, as long as they know ahead of time. In a more critical situation, it may be possible to negotiate with your vendors, to agree on a payment schedule that is more realistic for you. By communicating with vendors and keeping them informed of your situation, whether positive or negative, you will maintain good business relationships and will protect your credit with them.
For many small companies, payroll represents one of the biggest expenses they have each month. One way to even out cash flow is to pay on the 15th and the last day of each month instead of paying every two weeks. When you pay every two weeks, there are two months every year in which you will have three paydays. When the payments you receive are scheduled by month, having three payroll dates in the same month can be a significant burden on your cash flow.
When you pay commissions to sales people, you could condition the payments on collections from customers, in order to tie income to disbursements. In this case you would have to be clear about these conditions with sales people, and apply the policy consistently.
You should plan your cash flow to be able to pay payroll taxes by the due date, to avoid fines and penalties that apply on late payments.