Last month’s article focused on the first leg of this diagram. In this month’s article we’ll deal in some detail with the other two legs.
The sale of the inventory must include sufficient markup to cover all costs and to give the owners an adequate return on their invested capital. It is at this juncture that one must be careful not to be complacent. Markup is potential profit, but not real profit because cash is still tied up in Accounts Receivable.
Some sales managers and, in my experience, many sales representatives, feel that their job is done once the customer has accepted the product and placed the order. Nothing can be further from the truth. The best definition of a sale is that it is an exchange of goods and services for payment in kind. In other words, a sale is not complete until the check clears the bank. Until it does, the company has not made any real profit and has not even begun to enjoy the fruits of its labors but has been in the gift-giving business.
Whether the bookkeeper, credit manager, accountant, financial manager, treasurer or sales people are given the task of collections, it is in many ways one of the most important functions in a business, and the owners must pay it regular and careful attention. There are many reasons customers will give for late payment or, worse, non-payment. Some are real, some imagined, some invented and some sheer nonsense, and yet they must be handled and the money collected.
The biggest concern raised by many owners and senior managers is that “If I make them pay on my normal terms, they’ll buy from somebody else!” In some cases this may happen, but if you’ve developed a professional relationship with your customer, they know you are not in the banking business any more than they are. You must make this clear to them. Explain your needs and explain that they should want to deal with a professional and profitable company, one they can be sure will be around to service their routine and emergency needs. The Law of Business Balance states that neither they nor you can get something of value for nothing.
There are several programs and formulas for tracking and evaluating the status of Accounts Receivable. One of the most common is called “Days Sales Outstanding,” and this will be the subject of next month’s article.
Put in other terms, profit is to a company as food is to a person; cash flow is to a company as blood flow is to a person.
A person with a strong heart and clear arteries is considered healthy, yet, if there is a blockage or loss of blood they can quickly be in critical condition. An otherwise healthy-seeming business can allow inadequate or late collections with the resultant lack of adequate cash flow. And suddenly the company finds itself in critical condition.
An old fashioned treasurer with whom I once worked had a little sign in his office. It read: “Cash is your best friend. With it, you cannot be intimidated.” He was right!
About the Author
L. Douglas Mault is president of the Executive Advisory Institute, Yakima, Wash.
