Are you getting the best savings on your payments strategy?
Ask business owners what managing cash flow is about, and many will say: collecting promptly from customers and stretching out payment to vendors. That makes sense. If you collect from customers, you have cash coming in faster; and if you push out payment terms to vendors, you hold onto your cash longer. Both are smart moves in the cash management game.
Let’s take a look.
A common invoice is “2/10, net/30” — a 2% discount if paid within 10 days, or pay the net amount within 30 days. It’s tempting to hold onto your cash as long as possible and push payment out the full 30 days.
But what if you paid in 10 days and received the 2% discount? And let’s suppose your business has a line of credit to tap to be able to pay invoices within 10 days. Here’s the math on a $100,000 invoice:
On a $100,000 invoice, a 2% discount is $2,000. So, if you pay within 10 days, you’re paying $98,000. Suppose you use a business line of credit with a current rate of 4.50%, which is common in the market today. Your full-year’s interest would be $98,000 @ 4.50% = $4,410. The daily cost ($4,410/365) is $12.08. Let’s say you’ve still got the remaining 20 days of the net/30 terms of the invoice — so your borrowing cost is around $242.
You’re spending $242 to save $2,000.5 tips you may want to consider
Each business is unique, and this general scenario might not work for every business. Here are five things to consider:
1) Push for discounts with your suppliers. What if you could get a 5% discount for paying within 10 days?
2) Push for longer payment terms, too. If you can get net/45, go for it. There may come a time when you’ll find the longer payment terms beneficial.
3) Evaluate your business. If you have strong cash flow, such as a cash-and-carry type business where you’re paid immediately, you may not benefit from paying suppliers quickly or borrowing.
4) Watch interest rates. Rates are relatively low right now. If rates were to rise, you would want to do the math again to see if borrowing to take advantage of supplier discounts still pencils out.
5) Learn more about cash management. Cash management involves an array of strategies and potential financial tools to manage inflows and outflows of cash, help protect against payment fraud, and put your business’s cash to work for you. The more you know about the various strategies and services, the better prepared you and your business will be to navigate the world of cash management. Your banker may be able to help you with strategies for your particular business.
I hope my example helped prompt you to review your cash flow operations with a new perspective. Maybe you have some other ideas for maximizing savings? Please share them in the comments section below.