Thursday 18th Apr 2019
Managing cash in any business is critical. Your cash management strategy in terms of your daily/weekly/monthly/yearly trading is fundamentally about one measure that really matters: your debtor to creditor ratio. It still amazes me today how many business leaders, owners, and entrepreneurs don’t instantly know what their debtor and creditor numbers are running at, whether for the year to date or as a trend.
The simple fact is that nearly every business is both a creditor and a debtor, since businesses extend credit to their customers, and pay their suppliers on ‘delayed’ payment terms.
Cash can be what stifles the growth potential in your business and proactively managing the ratio between these two levers is key to being able to fund your growth ambitions.
When I work with clients and we start drilling into their financials and even more specifically, their debtor to creditor management come up as a key discussion area, without fail.
I’m normally drawn into a focused conversation where I end up making the following statement: ‘I didn’t realise that a secondary part of your business proposition was providing financing for your customers.’ Now I’m sure you know where I’m heading with this point.
You are not there to provide a free credit facility for your customers.
Don’t let your debtors treat you like one. It will cripple your growth potential and will lead to sleepless nights because you can’t pay your employees or your bills. Too many businesses fall into this trap, don’t be one of them.
It doesn’t have to be this way if you are proactive in your debtor management, and the great news is that this is not complicated to fix.
On the customer side it’s about two things: firstly, how creative you are in positioning your compelling value proposition and the associated payment terms; and secondly, your ability to negotiate effective terms, especially if you’re a small business and cash is tight.
Consider the builder who builds a wall around your house and then comes to you with a bill; if he hasn’t already got part payment from you to cover the materials – the bricks, cement, plaster, and paint – then he is using his own capital to secure those items. In the worst-case scenario, where a delinquent customer decides not to pay, or drags his feet in making payment, the supplier is not only waiting on an invoice, he is out of pocket. When I recently replaced my decking at home the supplier asked me to pay for the materials before he installed anything. At the very least, he wasn’t funding the job on my behalf.
Stage payments are a sound financial strategy in business today and most customers will understand that, as they are probably doing it themselves. Your customers simply need to pay you. There is nothing wrong with creating that expectation, nor any sense in being too polite about it. Not that your cash collection should be reminiscent of a hungry shark, but it must be consistent and it must focus on ensuring that your own cash management needs are taken care of.
One final thing that can make the world of difference for you in your debtor strategy is this…complete credit checks.
Where feasible make it an integral part of your up-front processes to check a customer’s credit rating at the point of agreeing to work with them. This used to be a cumbersome and expensive process. However, today it is simple – there are a number of credit check websites. It’s not just debtors paying late that can stifle the growth of your business, but the potential of having to write off bad debt.
If a potential customer comes up with a poor or indifferent credit rating you need to make a conscious and deliberate choice about whether you should be doing business with them in the first place, or, even more importantly, whether you can afford to.
Once you’ve got your debtor strategy on track you can then turn your attention to your creditors.
The second lever, creditors, is all about your effectiveness in negotiating payment terms with suppliers and partners to ensure you’re maximising your debtor to creditor ratio.
Of course there are other creative ways in which you can unlock the cash in your business, but this goes back to the gross profit margin you’re making, as there is always a cost involved in such solutions. While creative ideas such as these can work, you’re far better off managing your cash effectively so you can avoid the costs associated with using them.
Though it sounds mad, it often happens that companies get muddled up about the amount of money they have on hand at any one time, because often they’re simply holding it for someone else. Consider, for example, the revenue you collect on behalf of the Government in the form of corporation tax and VAT (or whatever the taxes are called in your country or jurisdiction).
Those amounts come into your account on payment of every invoice, but it’s critical that you ring fence them, perhaps by putting them into an entirely separate account, because they aren’t yours to spend.
I frequently see companies get a corporation tax or VAT bill – which is predictable and happens at regular intervals – and then have to scramble to find the cash to pay it because they’ve made the mistake of thinking that 100% of the cash in their accounts was their free cash flow to fund their daily business activity.
Corporation tax, VAT – or your equivalent – is not operating capital and if you find yourself using it as such, your business model simply isn’t working and you need to revisit the fundamentals of your business growth model.
Want to check the robustness of your cash management strategy?
Or the strength and depth of your business governance?
Complete The Business Growth Pathway Finance & Governance self-assessment and put an end to those sleepless nights.