As you manage your business from day-to-day you need liquidity, that is, cash. Cash is required to pay your bills from suppliers to your utilities bills and even your employees. So, where is this steady flow of cash coming from? Your customers! How do you increase your cash balances in your business? Let’s investigate the Operating Cycle and the steps that are involved in the conversion process.
In order to understand how to accelerate the cash conversion process is it important for you to understand your Operating Cycle. That is the amount of time it takes for you to convert cash to inventory to sales to accounts receivable to collections to cash again.
In any business, you begin it with cash as you can see below. You determine how to spend it whether it is on furniture and equipment or your raw materials. As your raw materials are converted into product you start building inventory. As your sales people become involved and start selling, your billing department bills and your accounts receivable balances increase. Depending upon the way your customers pay their bills, you may receive your money anywhere from 45 to 60 days. Then it is deposited in your checking account and the process starts all over again. At each stage of the Operating Cycle there is an opportunity to shorten cycle times.
Strategies to Improve Your Operating Cycle
Your accounts receivable levels are important to watch. Bills are usually collected on a 45 day basis. Some customers may even pay sooner than that. Those customers are gold. Others are not.
You should indicate clearly on your invoices what the terms of payment are. These are usually 10/20 net 30, meaning that if the bill is paid within 20 days, then the customer is entitled to take a 10% discount on the amount due. You benefit by collecting on that invoice sooner rather than later and having the money to run your business.
But consider the customer who pays in 60 days. This customer is costing you money! You are actually financing this customer to the tune of 36% a year. That is an incredible financing charge. Did you ever realize that you were becoming a bank by not collecting on these invoices? Therefore, it is critical to your cash flow to collect the amounts due you promptly. Hence, the time value of money: a dollar today is worth more than a dollar tomorrow.
Consider the following actions to take:
- Have your available cash reported to you daily and chart it against weekly Accounts Receivable and Accounts Payable Reports. These reports will indicate how long your invoices are outstanding and which ones to watch closely for delinquency. Your current ratio will be improved with monitoring and you will understand your business better.
- Get your bills out more quickly. Bill as soon as the shipment is sent out. Hire a person to do nothing but make sure invoicing is timely and follow up on payments. Send out friendly reminders at least 5 days before the deadline that payments are due.
- Follow-up calls to customers are important to remind them that the invoice is due. These calls will also reveal whether the order is received in good order and if the customer is happy with the shipment. Sometimes a customer will not pay on an order that is unsatisfactory because he is a small business and he is just too busy to make that phone call to you; he just holds the goods instead of returning them to you.
- Understand each customer’s payment cycle, and time your billings to coincide. Offer credit card payment, leasing options to make payment easier for them.
- If a customer is strapped for cash and cannot pay the total amount of the invoice, then you must ask him to pay something right away. Making an installment plan with him is beneficial to you and to him. You must collect something in order to make it easier for you to meet your cash demands, and he has just reduced the amount outstanding on that bill.
- Shorten cycles for delivery of your product. Work-in-progress times should be shortened for faster completion of projects, and the faster your will get paid.