I spend a lot of time with clients discussing cash flow. Leadership teams ask questions like, “Why is cash tight? We’re meeting [or exceeding] sales goals, but our cash position isn’t improving as we expected. What is happening?”
The answer is simple – you’ve become a bank. This happens when you misalign your payables and receivables, and your need to make the sale overshadows your ability to collect timely payments to ensure you have enough cash on hand to operate.
In business, managing payables and receivables effectively is crucial for maintaining healthy cash flow and financial stability. Below are some common issues associated with payables and receivables.
Payables Issues
Paying too early may affect liquidity – your ability to cover any short-term liabilities such as loans, wages, bills and taxes. Paying too late can incur penalties and damage supplier relationships to the point you may be cut off from your vendors.
Receivables Issues
Late payments from customers severely impacts cash flow, affecting your ability to cover operational costs and investments.
Extending credit to customers — becoming their bank — increases the risk of non-payment. Do you really need the sale at the expense of your company’s overall financial health? When does the one or a few clients dictate the cash flow and financial position of an entire company? If you are placating one client, perhaps you should re-think your goals and fire the client.
Strategies to Mitigate Issues
Terms: Negotiate terms that match your cash flow needs. Payables and receivables timing – Days Payables Outstanding (DPO) and Days Sales Outstanding (DSO) – should be as close to equal as possible. If you pay your bills in a net 30 manner, you need to make sure that your customers pay you within 30 days.
Calculating and tracking DPO and DSO should be part of your regular monthly financial reporting.
Automate Payments: Offer incentives for your customers who agree to automated payment systems, ensuring timely payments and reduce administrative burden for both parties. Participate in autopay with your vendors as well.
Credit Policy: Clearly communicate your established credit policy with prospective clients. If clients do not adhere to them then, perhaps, they are not the client for you. Define who is eligible for credit and under what conditions.
By recognizing and addressing payables and receivables issues and implementing robust processes, businesses can improve their cash flow and overall financial health.