One of the key factors in good cash flow is how you manage your Accounts Payables i.e. suppliers who give you terms to pay.
A key measurement in managing this, is knowing your average Accounts Payable Days. This is the number of days, on average, it takes you to pay all of your suppliers.
The way to calculate this number is:
Outstanding Supplier Amounts/Costs x 365
If you owe suppliers $ 200,000
Your direct costs are $1,000,000
Calculation: 200,000/1,000,000 x 365 = 73
This means that you are taking 73 days, on average, to pay your suppliers.
Once you know this number and can regularly measure, monitor and reduce it, you will be able to make improvements to your cash flow.
Accounts Payable may seem like a ‘ho hum’ kind of subject, but it can be a minefield of mistakes. Opportunities to improve your cashflow and profit abound in your Accounts Payable actions.
Accounts Payable is the ‘flip-side’ to Accounts Receivable. As we discussed in an earlier post your objective is to keep your cash in your bank account for as long as possible. Let’s discuss some ways you can achieve this objective.
Paying suppliers too much, too quickly and wasting discounts.
If you don’t pay any attention to Accounts Payable, you could be losing out on money and opportunities. Suppliers do make mistakes on invoices.
Paying suppliers too quickly is a common error made by many businesses.
It’s tempting when a supplier calls up to immediately get the boss to authorise a payment and get them ‘off your back’. This could be a very expensive reaction.
If you analyse your average days payable i.e. the number of days, on average, you take to pay your suppliers, you may be amazed how much money can come back into your bank account, if you can take the maximum credit terms. It can be tens of thousands of dollars. This is valuable cash for your business.
Conversely, not paying suppliers on time can be expensive too. If suppliers are willing to offer early payment discounts, you could be missing out on valuable profit.
If you have good Accounts Receivable procedures and get paid on time, this should put you in a position to pay suppliers on time and get those valuable early payment discounts. Again this can mean tens of thousands onto your bottom line. Only pay early if a discount is offered
Not recognizing the value you provide to suppliers and getting the best terms
It is so easy to keep going along with the same supplier because you always have, and not realize the value of the business you put their way. Some suppliers will not alert you to better value items or offer you better terms, so you have to keep a track of it yourself.
The best way to do this is by having a good system for tracking purchases. That way, it’s easy for you to print out a report on how much business you have done with a supplier over a period, and go back to them to negotiate better terms or even approach an alternative supplier. You can do this easily in your accounting system if it’s set up right i.e. if you are able to report on purchases from a particular supplier. Rather than just allocating payments to suppliers straight out of the bank account, it worth taking the extra step of recording each purchase against a supplier. This way you will have an easy record of exactly how much business you’ve done with them over a period. This makes it easier to negotiate for better prices and terms when the time comes.
Obviously service levels are important too, and if they are equal then the deciding factor could be the credit terms from a supplier. Again this could have the impact of tens of thousands of dollars into your bank account of vital cash.
Damaging your credit rating
Stringing out supplier payments with no agreed terms or strategy, can be very expensive in terms of your credit rating. Most good suppliers will expect you to complete a Credit Application, prior to doing business.
If you can’t provide good references, you may find it very difficult to get credit. Also if you have had a judgment against your business by a supplier, it could cause suppliers to give you a ‘wide berth’. This can be very damaging to cash flow if you have to purchase on COD terms.
Not knowing what you owe, to whom and for how long
If you don’t have a system for tracking Accounts Payable, then it’s very difficult to know your near and far future obligations and cash-flow position. If your business is growing this could cause huge headaches.
The last thing you want is to be going to the bank ‘cap in hand’ because you have run out of money. Banks see this type of approach as very unattractive and unprofessional. If you can go to them well before the event, and say “if this happens, I may need to borrow money, they will see you as a much better bet, as you demonstrate you have your ‘finger on the pulse’ of your business.
Not understanding the impact of Accounts Payable on ‘Working Capital’
Working Capital is a vital issue for every business and Accounts Payable makes up a large part of it i.e. the quicker you pay suppliers the worse off your working capital requirement will be.
‘Working Capital’ is the amount of cash you need to fund sales. If you offer credit terms to your customers and keep stock lying around for a while, the money tied up in these items is working capital.
Accounts payable adds to this requirement, so if you are paying suppliers haphazardly you could be ‘shooting yourself in the foot’ in regards to Working Capital.