I addressed the management of inventory levels to free up working capital/cash in another article. Now, I’ll offer a few tips to optimize accounts receivable and accounts payable.

 Accounts Receivable

In this tough economy, many business owners are quick to offer cash discounts to customers for early payment of invoices. Terms of 1%/10 or 2%/10, net 30 days are common. You say big deal, a 2% discount…whoopee! Well, it is a big deal….you are giving the customer a 2% discount for paying within 10 days, rather than 30 days…in other words 20 days early. There are approximately 18 twenty day periods in a year (18 x 20 days = 360 days in a year), so that 2% equates to a 36% annual interest rate. Even if you had to borrow from a line of credit to carry the invoice for the additional 20 days, the annual interest rate is certainly far less than 36%.

In addition, many firms offer customers “free freight” on orders exceeding $xxx. Give customers an incentive to pay invoices that qualify for “free freight” on a timely basis; but bill the freight on your invoice and include a message that the freight charge may be deducted only if the invoice is paid within terms. If a customer pays the invoice late, they must also pay the freight charges.

To increase sales as well as incentivize your customers to pay your invoices on time, offer them periodic (quarterly, semi-annual, etc.) rebates based on their increased purchases from you….the greater the increase, the bigger the rebate percentage. You issue the rebate as a credit to their account, but only if all their invoices are paid within terms.

Pay close attention to your Accounts Receivable Turnover/Days Outstanding – Ideally, the days outstanding should be less than or equal to your invoice terms. If your invoice terms are net 30 days, your days outstanding should be 30 days or less. If you have both sales on account and sales that are paid at time of shipment or delivery, be sure to include only sales on account in the computation:

Sales on account for the month                           $1,000,000

Accounts Receivable (net):

   Beginning of the month                                    $1,100,000

   End of the month                                            $1,210,000

   Average                                                          $1,155,000

Accounts Receivable Turnover/Days Outstanding:

   $1,000,000 Sales/30 days = $33,333 sales per day

   $1,155,000 Average O/S A/R /$33,333 sales per day = 34.65 days

Cash tied up in A/R above 30 day invoice terms = $33,333 x 4.65 days = $154,998

Accounts Payable

Paying vendors on a timely basis is worth its weight in gold. Vendors are more likely to accommodate your special requests and be willing to “cut deals” if you have a solid track record of paying their invoices within terms. I do not advocate paying vendors early (unless you get something in return), but do not pay them late (unless they are willing to extend your payment terms, e.g. from net 30 days to net 60 days).  Vendors are seeking ways to improve their cash flows too. Negotiate early payment terms, such as 2%/10, net 30 days. What is too costly for you to offer to a customer, is too good to pass up when paying vendors! I had over 100 vendors in my distribution business and was able to negotiate early payment discounts with most, including one vendor from whom I purchased about $500,000 a year at a 4%/10, net 30 days…resulting in an additional $20,000 a year in profits.

Charlie Yacoobian, CPA is a partner in the firm B2BCFO®, offering comprehensive CFO services on a long-term/part-time, as-needed basis to small and mid-size businesses and can be reached at (661)714-2588 or cyacoobian@b2bcfo.com.