Leveraging Accounts Receivable To Pay Accounts Payable On Time
There are companies that would prefer to pay all of the accounts payable when due
. However, it becomes difficult for small companies particularly that are growing to be able to finance the disparity. If there was a way of shortening the A.R. cycle, it might be possible to pay all the bills and meet payroll when due.
However, we don't live in the ideal world. According to some sources, before a downturn in the economy, the average net-30 cycle was extending to fifty-four days. The average time it has taken since a downturn in the economy went from fifty-four days to fifty-five days. Yet, in order for companies to stay within the accounts payable cycle of thirty days, it is difficult because the accounts receivable cycle is almost twice that of the accounts payable.
In some cases, it is possible to make arrangements with suppliers to wait until your client pays you for goods and services you have provided. This is particularly true when the supplier is a smaller company really needing your business. Smaller companies seem to be more tolerant of an extension but larger companies may not be as tolerant. On the other hand, larger companies use their clout to exploit that thirty-day cycle knowing how badly smaller companies want to continue doing business with them.
There is quite a lot of disparity between small companies and large companies. It is not a level playing field for small companies as compared to larger companies. Larger companies generally have more capitalization and clout to play the game differently. It may not be fair but it is the reality of doing business. So large companies are generally not confined by the same parameters as small companies.
Since large businesses generally are more capable through better capitalization, it becomes necessary for smaller businesses to be creative in generating a positive cash flow. Smaller companies are not always able to qualify for the funds they need in order to have the piece of mind that comes with positive cash flow. Therefore, it often becomes necessary to look at alternative sources of financing.
When a small company is in a growing cycle, there is often disparity between the A.R. cycle and the A.P. cycle. When that disparity exists, it is often difficult if not impossible to meet obligations when due. Ideally, if the company is growing and making a profit, it should not have difficulty staying current on paying bills, meeting payroll and taxes. However, the reality is that there are going to be cash flow problems due to accounts receivable not being collected quickly enough to meet all of the obligations.
It is more difficult to qualify for conventional loans for many small companies. Therefore, in order to finance the disparity between the A.R. and A.P. cycle. A viable alternative for business to business and/or business to government invoices is to factor the invoices. It is a debt-free way of converting accounts receivable into cash. It doesn't adversely effect the balance sheet because it is the sale of an asset rather than a loan.
Factoring principles are used in credit card financing. When a merchant accepts a credit card, he is paid almost immediately when the credit card invoice is submitted. Usually the invoices and funds are electronically transferred. A savvy businessman knows the way he pays for the discount on credit cards is to pass the cost on to the customer. He is paid by the credit card company in one installment.
The discount if subtracted from the reserve. The merchant does not have to worry about doing due diligence on his customer. It is the responsibility of the credit card company. One purpose of the discount is for the credit card company to take a certain degree of risk.
Factoring involves two installments. A percentage is advanced to the business once the invoice has been submitted to the factor. The reserve is held by the factor as security until the client pays the invoice. The factor pays a second installment minus a discount fee after the invoice has been paid by the client. It is very similar to credit card financing. However, factoring is only available for business to business and business to government invoicing. But again, the factor is more interested in the client's credit than the business benefiting from the factoring process. The risk the factor has is with the client.
Factoring is always considered to be time sensitive and transitional until a company qualifies for conventional financing. A company may consider factoring for several months until the cash flow problem is resolved. Then it should obtain funds from more conventional sources at less expense. However, considering the time value of money, factoring can be viable at a certain stage of development of a company. It is difficult for a company to grow unless the cash flow is positive.
by: Russell Wardle
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