Finance: KNOW YOUR BUSINESS TO GROW YOUR BUSINESS

Lori Kudish, President of LTL Financial Consultants, reports: Some of my previous posts have dealt with explaining the accounts receivable collection cycle and managing your expenses. This time I want to tie the two concepts together and talk about the connection between how you handle your receivables and payables. It may not seem on the surface that these two concepts are really related as they sit on complete opposite ends of your business. In fact the link is very strong between how you manage both of these areas and the overall financial health of your company.

The difference in days between when you collect receipts from your customers and have to pay out to your vendors can be called the float. Your aim is for there to be at least some time between these two events. Ideally you want to set up your business so that you can be sure to receive funds in with sufficient time before you have to pay out to your vendors. This will allow for the inevitable late paying customers and also the likelihood that you may not ship out all of your inventory immediately upon completion. Here is an example of your preferred scenario:

Day 1: You received a new batch of inventory from your vendor-you now have 45 days to pay the invoice ($100) from the supplier.

Day 2: You ship all of the inventory out to your customers and invoice them ($200) with 30 day terms.

Day 32: Your customers all pay promptly and in full ($200).

Day 45: You pay your vendors promptly and in full ($100). You are left with $100 in cash flow to pay your other expenses and reinvest in the business.


In this fairytale version no one pays late, customers don’t take unanticipated deductions, checks are not lost in the mail and they all clear on the day they are deposited. Here is an illustration of how things might look if your terms are not set up correctly:

Day 1: You received a new batch of inventory from your vendor-you now have 30 days to pay the invoice ($100) from the supplier.

Day 2: You ship out just $25 of the new inventory to Customer A for a total invoice value of $50. You don’t get around to sending out the invoice until day 7.

Day 14: You ship out another $50 of inventory to Customer B for a total invoice value of $100.

Day 31: Your invoice to the vendor is due today, but you have yet to receive payment from either of your customers. You also still have $25 worth of the inventory sitting in your warehouse. You are now officially in a cash crunch…

Day 32: You are expecting payment from Customer A, but they did not receive and process your invoice until day 12. They don’t have your invoice scheduled to pay until Day 42, and then it will be held in-house for another 5 days.

Day 44: You are expecting a payment of $100 from Customer B today, but it was just mailed today, and they are deducting $15 because your trucker missed a delivery appointment.

Day 46: You finally receive payment from both customers today and can pay your vendor. This has not left the vendor feeling very good about your payment history, and he may consider not extending terms to you at all in the future.

You can see that with a few small adjustments, the fairytale can end a very different way. The way you have structured your receivables and payables leaves absolutely no room for error. You can see from this small example why it is important to get the longest terms possible from your vendors and give the shortest terms you can to your customers. If you were able to negotiate 90 day terms on your payables, it gives you even more breathing room to sell out the complete run of inventory and collect from all of your customers. It is also important to remember that your customers will generally not start counting down the 30 day terms until your merchandise has been marked received in their warehouse and they have taken their time in processing your invoice through their system. With this in mind, it is crucial to get the invoices in your customer’s hands as quickly as possible.

You also need to remember these issues if you have a service business. You should require some interim payments from your customers if you are going to have to pay vendors or employees before a project is complete. For instance, you can request a retainer up front and then monthly payments until completion, or you can work on a percentage of completion basis. In any case, be sure to structure the outbound payments so that you allow yourself sufficient time between when you expect to collect and you are required to pay.

Please think about these longer term concerns as you are laying out the structure for your business. I know it can be difficult to see beyond the struggle to land that next customer, but it is so critical to set your organization up for success!

You can reach Lori Kudish, President of LTL at: lkudish@ltlconsults.com

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