The cliché ‘revenue is vanity, profit is sanity; but cash is king’, and its variations like ‘cash is reality’ or ‘cash flow is king’ has a certain truth about it. In simple language, it means managing the timely payments from your customers. The businesses and business schools tend to play around with terminologies but it boils down to one purpose-availability of cash.
Collection and cash flow management are intertwined. The collection plays a vital role in all businesses, which cannot survive without the availability of sufficient cash at their disposal most of the times. Cash flow management entails, both in and outflow of cash in such a manner that your debtors and creditors are in sync. It becomes crucial in times of credit crunch and recession; meaning that accessing additional cash/working capital from financial institutions may be problematic and expensive.
Technology has made life easier to manage collections. Today, many state of the art bookkeeping systems as well as trying to find online resources for business solutions such as templates for invoices and so on, allow you to manage your collection mechanism and keep it up to date. So, if you are still running the primitive bookkeeping, it is time to consider changing that on war footing.
These bookkeeping systems come with a comprehensive collection and cash flow management programs. They not only generate invoices in real-time, but also provide you with all kinds of management reports, missing payment reports, ageing of receivables and payables, default customers reports and many others. You must review them though at breakfast.
It should be an established policy
Smart business managers establish the collection policies from the inception. Call it the conventional wisdom. It will be wishful thinking that in a depressed economic cycle, you may pressure your buyers to pay you earlier and later to your suppliers. Both will default and take you along with them.
Generally, when extending credit terms to your buyers, you have to take into consideration a number of factors, e.g. creditworthiness, the track record of payments, market reputation and fall back option. Otherwise, transactions should be cash-based even on a discount, which is better than default.
Credit is granted against a certain contract, which delineates the terms, payment dates, revolving credit, if any, rights and responsibilities of the parties and the consequences. If such contract is not available in your business, ask a lawyer to draft one for you. Remember, it should be client-specific and agreement based.
Payables determine Receivables
The raw material, finished goods or services when acquired carry a price that you need to pay to the vendor. What you agree here is the foundation of your sales policy.
In simple accounting, it translates that your sales terms should be shorter than your payment terms. Extending long term credit to your buyers for the sake of boosting your sales numbers may not be a viable strategy unless you have unlimited equity to inject into the business.
The difference in the number of days between receivables and payables should be around 30-45 days, which will give you reasonable breathing time in a downward cycle.
A common flaw occurs when sufficient cash is available and some smart cookie consumes it in a long-term project, which may benefit the business in the long run. Avoid that impulse. Excess cash should be kept at all times either in an interest-bearing bank account or invested in liquid securities that can be encashed within 48 hours max. Most businesses put an upper limit on the availability of cash and working capital at hand.
Once a business grows and red lights start blinking on your collection; it is time to hire necessary qualified staff to dedicate their time in the collection only. Such an expense has always proven to be worthwhile. The collection has certain standardized rules; it is not an exercise a la Capone. You should hire only those people who have certain background and knack of dealing with customers in your field. Major defaulters should be the responsibility of senior management. In bigger firms, collection teams even get performance-based bonuses. Collection team should be duly trained in prioritizing the clients.
Outsourcing is another tool at your disposal when you hand over your defaulted invoices to an outside agency that specializes in collection against a certain fee. Outsourcing is a costly affair, but has the advantage that the legal implications are transferred to the agency.
Tracking & Monitoring
You need to develop a well-defined tracking and monitoring mechanism through the use of technology. However, it almost always requires senior management and active shareholder involvement, who guide the teams. Tracking also demands an established follow-up policy, which addresses a host of questions. When a payment should be called ‘delayed’ and when it should fall into the category of ‘default’? What action plan is agreed in each scenario? When to consult a lawyer and initiate legal action? Who is the client? What are the possible consequences?
Recovery through restructuring
The reality is that clients delay and default. You cannot have a perfect relationship, although you may have a near-perfect system. The legal system is fraught with loopholes of various sizes. When you encounter cash flow problems, there could be many factors. There is a possibility that your own policies or monitoring need reset. When a certain client defaults, ‘see you in court’ should not be an automatic route to follow. The economy and business circumstances, meaning underlying reasons for default, ought to be taken into consideration. A smart manager should be in a position to offer multiple solutions to the client like restructuring the payable amount through various methods and periods.
Overall, tips, techniques and strategies are clever to the extent that you implement them, involve yourself and monitor the results. In spite of its overriding significance in the survival of a business, it has been a pressing concern among the industry players. According to the statistics, in the USA 20% of small businesses fail in their first year, 30% of small businesses fail in their second year, and 50% of small businesses fail after five years in business. Finally, 70% of small business owners fail in their 10th year in business. Most of them due to cash flow mismanagement. You definitely would not like to fall into those categories.