Unbiased financial information provided by Financial Wisdom.
With most small businesses, cash is king. By that we mean that one of your most important tasks is managing your cash flow to ensure there are funds available for meeting your operating needs and funds available to enable you to take advantage of opportunities for growth.
Optimizing your operating cash flow really boils down to three basic rules:
- Get money you are due as fast as possible.
- Pay money you owe as late as possible.
- Earn as much as you can on your cash balances.
Unless you are in a retail business, most receipts for sales or services performed take place some time after the sale actually occurs. A sale is made, goods are shipped or services are performed, an invoice is presented and you wait for payment. Here are three ideas for accelerating when you receive payment:
- Identify a billable event, other than delivery. It is common to have partial billings on large jobs or when the job will take some protracted period of time. Consider using some event or milestone as a trigger for an invoice. It could be passing a design review, completing a critical test, or receiving a large amount of material. If negotiated into the sale, these events could authorize you to issue an invoice before the job is totally completed.
- Set payment dates. Your customers are trying to optimize their cash flow the same as you. In the sales process, and certainly on the invoice, state when payment is due. Whether it is the common "30 days" or with a "1% discount for payment within 10 days", customers will be more likely to respond to specified dates and terms. Sales to poor credits should be COD. Once the payment date is established in your contract, you have a legally enforceable document.
- Establish late payment penalties. As Oscar Wilde said, "Nothing focuses the mind like the sight of the gallows." Customers respond and your chances of collecting interest from delinquent accounts improve with a stated policy.
Holding on to your money as long as possible also improves your operating cash flow and enables you to earn interest on your funds.
- With major suppliers it may be possible to negotiate a more flexible payment schedule. They want your business and are often willing to respond with payment terms, especially if the materials you are buying are being used over an extended period. The time to approach the supplier is when placing the order. They are more willing to consider this before they have your order in hand.
- A second issue to consider when you are the customer is some form of discount for prompt payment. While the practice has become less common, some organizations still offer a 1% or 2% discount if their invoices are paid within a shorter period. A 1% discount for payment within 10 days equates to a 36% annualized return on your money. If your cash flow allows it, taking advantage of prompt payment discounts may be the best return on your investment.
Finally, you should make sure you are earning as much as you can on your excess cash balances.
- While certain banking laws may restrict paying interest on commercial accounts, you should at least check with several banks to learn their policies.
- Some banks offer "sweep" arrangements that automatically more amounts in excess of some minimum into an interest bearing account. Talk to your banker.
Cash and time are two of your most precious resources. Spending some time setting accounts receivable policies, negotiating payment schedules with vendors and finding the right account(s) for your cash will help you maximize both.