Saturday, January 1, 2011

Cash Flow Tip #1: Stretching Out Payables

Cash flow tips are a list of tips I'll be presenting on ways to improve the cash flow in your business. They will cover a wide range of topics. They are not pie in the sky ideas, but tried and true methods I've used with clients or the companies I've managed. I decided to pick a somewhat simple one today in talking about your accounts payable.

One way to improve your cash flow, especially in the short run, is to stretch out your accounts payable, in other words, taking longer to pay them. For example, let's say you purchased $100,000 of widgets from XYZ, Inc. with Net 30 day terms. XYZ expects payment from you in 30 days obviously, but if you take 45 days to pay, you've now used XYZ's money for an additional 15 days with (theoretically) no cost of money. When I discuss this with clients, I get two responses, either 1) you can't do that, it's unethical, or 2) of course you would, industry average is 45 days to pay anyhow. Both answers are wrong.

First, the unethical argument. I would not recommend stretching out a payment like this without talking to the vendor first. Especially in our example of a large invoice taking an extra 15 days over terms. Over the years, I've found most (not all, but most) vendors very willing to allow you extra time to pay an invoice whether you are in a cash flow crunch or your business is seasonal, IF (that's a big IF) you call them up front and talk about it. For some reason, most people are averse to this, but I highly recommend it. Calling up front helps you establish a relationship with the vendor and lays a groundwork should you attempt to renegotiate terms to 45 or 60 days.

Try calling to renegotiate terms with a vendor or ask for a favor if you've been paying 15 days late on all your invoices and there is no relationship and you are typically in for a big surprise. Which addresses the second response of 45 days being industry average. Yes, in most cases that's true and in some cases vendors don't care that you pay late, don't know you pay late or will ignore your late payments until it is time to renegotiate terms or pricing. With no relationship with your vendor and late payment history, you stand in a difficult position to renegotiate.

I've worked with numerous vendors to modify terms either temporarily or permanently. Most recently working with a manufacturer with very slow sales in the 1st quarter due to seasonality. When you have regular conversation with vendors, they often anticipate the call and again, most are willing to work with you. Assuming you have an average payables balance of $500,000 and let's assume you are able to get all of your vendors to agree to temporary 45 day terms, that's $250,000 in cash or that you don't have to draw on your line of credit.

I'll repeat again how important that communication is, especially in this economy when many companies are stretching out their vendors to stay alive as a last ditch effort. That's not what I am talking about here and is a much different, urgent issue. You need to communicate to your vendor what you need and why so they don't assume you are in last ditch effort mode!