Companies today are faced with tighter lending, slower growth projections and leaner profit margins than they were several years ago, all of which is putting a bigger strain on corporate cash flows. One of the ways to help combat these challenges is to improve your own internal cash flows, particularly by focusing on three key areas—inventory, accounts receivable and accounts payable. Even making adjustments in just one of these areas can often have a positive impact on cash flows and reduce the amount of dependency a company may have on external borrowings.
Companies often overlook how much it costs to maintain inventory. There are real costs associated with the amount of inventory a company keeps on hand at any given point. First, the levels of inventory impact the size of the warehouse that is needed. The size of the warehouse in turn directly drives many other costs such as rent, real estate taxes, utilities and insurance. Secondly, the amount of inventory also has an impact on the number of personnel needed to oversee and handle the inventory. Keeping a close watch not only on the levels, but also the variety of inventory maintained has a direct impact on controlling and positively improving cash flows.
Monitoring accounts receivable
A company can post outstanding sales, but if it doesn’t collect the cash, the sales won’t have a positive impact. A company’s ability to effectively monitor its accounts receivable is critical to generating positive cash flows. Organizations that have strict credit policies and manage their credit risk are much more effective at controlling their cash flows than those that don’t. Companies with tight controls often put services or product delivery on hold until a customer becomes current. This enables organizations to allocate their resources to their more productive customer base and often increase profits.
Managing accounts payable
Most privately held companies have significant control over their accounts payable, but may not manage them effectively.
Taking a thoughtful approach to the payments a company makes to its vendors can generate some positive cash flows for the business. For instance, some vendors offer discounts, but management should evaluate these discounts to determine whether taking advantage of them makes sense. If the company needs to borrow on a line of credit to take advantage of a discount, it may end up paying more in interest expense, thus negating the benefits of taking the discount. Some companies pride themselves on paying all vendors within 15 or 30 days regardless of payment terms. This practice may be well intended, but doing so increases the amount of “float,” or the difference between the time it takes to collect from customers and the time it takes to pay vendors. Increased amounts of float can create a greater need for external borrowing. Therefore, evaluating the company’s vendor payment policies can be important.
Another strategy when dealing with vendors is to determine if there are ways to extend payment terms to better match the average collection period of customer payments. This can be an effective way of managing the float.
Finally, before making a major purchase from a vendor, companies should inquire about special financing that may be available. Depending upon the industry, low or no interest financing for a period may be available.
In the end, the difference between the time it takes to collect from customers and the time needed to pay vendors can either positively or negatively affect the company’s cash flows. The ability to effectively manage or reduce float allows companies to create their own internal financing.