It is just as important to handle vendor payments properly. Did you know that paying your vendors too early can adversely affect the business cash flow? Proper management of vendor payments is a key to having better cash flow.
Accounts Payable Turnover – This ratio measures how quickly you pay your bills. The higher the number, normally the better a company’s credit rating. Although having a good credit rating is desirable, the business’ credit rating is not affected when it chooses to pay vendors on time rather than earlier. Here is why it may be better to wait.
Opportunity Cost – Paying your bills to vendors as soon as you receive them is not a good cash management system. Although you are making your suppliers happy with your promptness, you may be hurting your cash position in the short term. When you pay early you are using your cash for items that may not necessarily be critical to your business that week. Cash for important payments like payroll, rent, and insurance should be considered before paying vendor payments. Paying bills early may prevent you from taking advantage of other business opportunities if the cash is already used. Managing when you pay your invoices is just as important as managing your customer collection process. You want to hold on to your cash as long as possible. Make it your policy to pay invoices when they are due.
Free Money – Some of your suppliers may offer cash discounts to pay an invoice within 10, 15, or 20 days. You may see payment terms on an invoice such as 2% Net 10. This payment term means if you pay the invoice within 10 days the vendor will discount the invoice 2% of the cost. Here’s an example, if your invoice was $10,000 and you pay the invoice within 10 days, you would only pay the vendor $9800. Make sure to pay these invoices early. Many times, the vendor will require that the payment is received by the 10th day to take advantage of the discount. These discounts can add up over the year and reduce your costs to the business. When possible always take advantage of cash discounts. This is free money that goes directly to your bottom line.
New Ways to Pay – Your vendors may offer various forms of payment such as ACH payments, online payments, credit card payments or other automated processes. These are all opportunities for you to hang on to your funds until the due dates of invoices. This allows you to manage your cash more effectively. You can also save time and money by automating monthly payments such as phone bills, rent, and leasing agreements.
Virtual Credit Card – Your local banker or credit card company may offer payment by virtual credit card. Instead of paying your vendors by check you use a virtual credit card number. You approve invoices for payment just like you would for a check run. Once the payment run is approved you upload a file to the credit card provider to pay your vendors. The provider sends payment to the vendor. You receive a detailed invoice showing all the payments and when the payments have cleared. For using this service credit card providers pay you a monthly rebate or cash reward. Check with your local banker or credit card provider to see if you qualify for this method of payment.
Best Practice – Create a 13 week cash forecast for your company. This is a simple cash budget that will show you when your expenses are due. The cash forecast should include the cash the business expects to collect from customers and business expenses for each week
In a typical cash forecast some weeks will show the business short on cash and other weeks will show the business with cash reserves. Over the 13 week forecast the total cash forecast should be positive.
Having a cash forecast and vendor payment plan is key to controlling cash flow and cash reserves.