Where Is My Cash Flow?

What do I do about customers who consistently pay late?  Why does it seem that the money flows out faster than it flows in?

These are significant questions for every business.  Managing the cash flow is critical to a business’s viability.  The cash flow equation and conversion cycle has several components:

- Actual cash
- Inventory
- Accounts receivable
- Accounts payable.

Managing each of these components and understanding the impact and implications to the “cash available” is important.  A recent addition to the complexity of cash management is the impact of the Check 21 Act.  It makes each check written a nearly instantaneous conversion to a cash payment out of your account but does not require that the funds you deposit be paid “instantaneously” available).  It is a rare business that isn’t focused on managing the cash balance and cycle.

Actual cash needed at any point in time or over a certain period is tied to your operational decisions, level of business activity, and the terms of “acquisition” for your business inputs – labor, materials, supplies, etc.  The greater the magnitude of the demand for inputs in your “production and delivery process” the greater the cash demand.  If you are able to negotiate favorable terms with your suppliers, you are able to delay the outflow of cash for those resources while employing those resources to generate sales.  In fact, when your business is experiencing significant growth, cash demands are usually the strongest.  Success demands CASH!

As you make sales, your customers are either paying you cash today or you are granting them terms – time to pay – which delays your cash inflow.  The amount of time you take to collect from your customers and the amount of time your suppliers/vendors take to collect from you – how synchronized those periods are – influences/impacts your cash availability.  For companies that sell goods the amount of time the product sets on the shelf before purchase – inventory turnover – further impacts the cash equation.

The impact of “terms”- net 30, 2/10, and others – is measured in the days of cash that are made available to the company by extending the amount of time between when a purchase transaction occurs and when it must be paid for, and the reciprocal – making the sale and then collecting the cash from the customer.  Two parts of the same equation.  How successful you are in gaining favorable terms from your suppliers and granting and enforcing your terms to your customers makes all the difference to your business.

When terms are agreed to, they should be adhered to.  Not meeting the terms extended by a supplier/vendor shifts the burden to them for carrying your business.  The repercussions can include:
•    Cash only transactions
•    Loss of credit rating
•    Loss of supplier as a source
•    Bad public relations

Businesses often “manage” cash flow by not paying the invoice on time or in full.  This is an all too common practice – you’ll get paid when we get paid – is also a frequent refrain.  Business transactions are about both parties benefiting from the relationship.  When one party unfairly burdens the other by failing to meet the agreed terms – it is bad for credit ratings and it is bad for business.

If you are a company with customers/clients who aren’t adhering to credit terms, then it is time to analyze just how good a customer that customer really is.  In evaluating the customer keep in mind that the cost of “floating a loan” to that customer needs to be in the equation.  You also need to consider the cost of not having the merchandise available to sell to someone who will pay on time and in full.  There are other effects on your business processes that also increase the cost of doing business with them – the time and effort spent trying to collect, the other uses of the funds deployed to cover that costs, the inability to use those funds to grow the business, pursue another opportunity, etc.

From the beginning of the cash conversion cycle, acquiring the inputs for the “sale” whether they are products, inventory, or worker hours, the clock starts ticking on the need for cash.  The timing of those flows and how long it takes you to convert the inputs into a sale and then collection of cash is measure of how quickly your cash conversion process moves.  If you have instituted credit terms that are net 30 and your customers average net 45 or more, then the implications to your business can be catastrophic.

If your vendor extends to you net 30 terms, you have 30 days from receipt of an accurate invoice to pay.  If you make a sale to customers on day 31 and extend to your customer net 30 terms, then you should be paying your vendor on day 30, before your customer buys from you and you still have 30 days before you will receive cash from your customer – if they pay on time.

If the same vendor purchase is on cash only terms due to slow payments or late payments, then you spend cash to acquire merchandise to sell.  So cash flows out on day one, and if the customer buys from you in 30 days with net 30 terms, you have your cash tied up in inventory and accounts receivable for 60 days.

The importance of establishing and maintaining sound credit policies with your vendors and with your customers can’t be emphasized enough.  Negotiating credit terms with your vendors that you can live with is important.  Meeting or doing better than those terms can provide you with options your business won’t have with poor credit.  Then your only option is cash only transactions.

Deciding what credit terms to extend to customers and how to determine which customers get which terms means making clear decisions, setting guidelines for granting credit, and getting credit references on your customers.  A business may choose to do cash only or cash and credit cards only – no checks, no terms (accounts receivable).  Depending upon your business, this may severely limit your customer base.  On the other hand, your business may choose to offer credit terms of net 15, 30, 45, 60 or even longer.  Companies also provide incentives for customers to “opt” for cash by providing discounts for paying cash at time of purchase or within a short period of time say 2% discount if paid within 10 days (2/10, net 30).  Whatever credit policies and terms you decide on, your business will also need guidelines for deciding when to refuse credit, put customers on cash only, and other key decisions.

Customers are necessary to business.  Profitable customers are critical.  Do you know which of your customers provide the most profit?  It may not be your most frequent or largest customer.  Analyzing your customer accounts on an annual, quarterly or even monthly basis can provide you with important insights into what it is costing you to get and keep the business.  The cost of the sale includes cost of goods sold, financing (terms and late payments), special handling, internal resources devoted to supporting a particular customer, and all the other direct and indirect support of getting and keeping the sale.  If you don’t know which customers are generating the most profit and are consistently on time (or early) in payments, then it is time to take a look, analyze, and understand that you might be more profitable without some of your customers.

Copyright © 2004 F.O.C.U.S. Resource, Inc.