“Money is the key to financial success” David Kleinbard
Cash or Credit? Cash Every Time!
Everybody has heard the expression about a bird in the hand being worth two in the bush. The earliest known English version of this proverb is from an English translation of the Bible during 1382. The English are definitely not the only language and culture to have a proverb reinforcing the concept that a definite immediate gain is better than the mere possibility of more gain later. Simply put, rather be paid slightly less cash now than marginally more later. The decision will be “cash or credit” and until you feel you can start losing money on clients, the answer is cash!
During the course of this blog there will be a number of articles with invaluable cash flow management and budgeting tips. I will explore the basic essentials of cash forecasting, arguably the most critical management tool at your disposal. Unfortunately, cash flow forecasts are usually explained by academics in a complex manner that is not easy to understand. But we will introduce you to a user-friendly model later in this blog for which you will need only a basic understanding of your business’ accounts.
Right now, I want to introduce you to an essential to your start-up business – Cash is King! Credit is expensive and deprives your business of working capital. It is easy enough to understand that if you have cash, you are able to spend that cash to make yet more. When you start a business, you generally have a fixed amount of capital that is available or that you intend to invest. The more often (or quicker) you are able to cycle cash full circle from spending it on stock to receiving it back in payment from your customer, adding your margin onto it every cycle, the greater your chance of succeeding.
Do Not Fund Established Business
I hold the view that a small and young business should avoid at all costs extending credit to large established customers. Why should your infant business effectively finance their larger and more mature business? This sounds very simple but it quickly becomes apparent after starting a business that in order to lure new customers you must often offer something that your competitors cannot. Entrepreneurs imagine that offering more favourable credit terms is the nectar that will attract the butterflies. It is. But it will also stretch your capital thin and if just one or two customers fail to pay on due date, you will be in deep trouble.
Is there a solution to this trap? Indeed there is!
When you budget for the first few shaky steps of teaching your business to walk and eventually run, try and cater for discounted sales pricing of a few percent for the first twelve months. Your discount need not be massive (possibly between 5-10%), but remember, you will be trying to secure new customers and must give them a reason for ordering your services or goods and taking a risk on you, rather than staying with their existing service provider or supplier.
Another option to you, that we will also explore in future articles, would be to secure “factoring” or “discounting” of invoices. This is a hugely useful financial tool and a simplified example is: You invoice your customer for $1000, payable in 30 days. The factoring house (much like a bank) will pay you $910 upfront, immediately and keep a $90 fee for taking on the risk of giving credit to your customer. Your customer will pay the factoring house $1000 when it falls due in 60 days. There are numerous ways to structure a deal like this, but the essence of it is that a third party effectively gives your customer credit, you pay a service fee for this BUT you receive upfront payment of your invoices.
You now have cash again immediately and here is an example of what you can achieve with immediate payment, rather than in 60 days’ time (over 8 weeks). You can turn your $910 into $1457.47 – skip the next three paragraphs if you don’t need to follow the numbers step by step, but I need to process each step in my mind…
You use your $910 to buy raw material, manufacture your product in two weeks and sell it within a week. You make your standard 30% markup, so your $910 is now worth $1183 (910*130%). Your invoice is again discounted and paid immediately for $1064.70 (1183*90%).
You repeat the process, now into week number 5, sell for $1384.11 (1064.70*130%) and are immediately paid the discounted amount of $1245.70 (1384.11*90%).
You repeat the process one last time, in the eighth week. You sell for $1619.41 (1245.70*130%) and are immediately paid the discounted amount of $1457.47 (1619.41*90%).
Cash in Your Bank Account, Not in Your Books
And we are now back at the issue of cash flow management… having come full circle, but simply skipped out the expensive bit where your little business extends credit and thereby finances a larger business. You have received payment immediately after invoicing the goods and your customer has achieved the discount, or through factoring, the extended credit terms they were wanting. The challenge of cash or credit is solved to both parties’ satisfaction.
With some simple ideas, instead of receiving $1000 in sixty days, you received $910 immediately and had working capital. Hey presto! This working capital gave you the facility to have $1457.47 at the end of that same sixty day time period! Cash in the hand is worth two in the books, well almost two…
As we all learn in business, the numbers never lie.