Strategy and Policy Determine Accounts Receivable Cycle
The choices you make regarding your marketing channels, invoicing discipline, and sales terms may offer the best chances to reduce your cash cycle and decrease the amount of cash you need to grow your business.
A simple – but sometimes overlooked – way to trim your days receivable and cash cycle is to make sure you invoice your customers immediately upon shipping their order.OPEN THE CASH CYCLE MODEL
In order to accelerate collections, you face some choices:
- Your marketing channel strategy will determine how much leeway you have regarding your payment terms. If you sell direct to consumers, you may have the opportunity to require immediate payment by debit or credit card. In that case, your collection cycle will usually be a matter of a few days. If you sell indirect to wholesale customers, you’re likely to be expected to offer payment terms of 30 days or more. Big customers will pay you…but they may take their sweet time.
- Even if do offer payment terms, you can get creative about the combinations of purchase quantity, price, and payment terms you offer. Sometimes, trading profitability for a shorter cash cycle might make sense.
- If a customer pays late chronically, you may want to reconsider your relationship. If they are stretching their payable to you, it might be a sign of deeper financial distress on their part.
The Cash Required to Support Growth Varies
Consider two variations on a theme. In one scenario, invoices are collected in 45 days on average (the blue line below). In the second – which experiences identical sales over time – invoices are collected in 7 days on average (the green line).
By the end of the 36-month forecast period shown above, accounts receivable under the two scenarios reach $13,300 and $2,140, respectively. The 7-day collection cycle is, unsurprisingly, more cash efficient in that it ties up some $11,160 less cash than the 45-day collection cycle. That money you can invest in inventory, equipment, salaries, or profit distribution. The profit in both scenarios is, presumably, the same. Why not find ways to have your profit and eat your cash cake, too?