by MHolland | Apr 9, 2024 | Accounts Receivables, Business Tips, Cash Flow
Selling something, whether a product or a service, and not getting paid is brutally painful.
Sloppiness in your billing process will cost you. The ultimate cost is not getting paid.
As I have written about many times before, the cost of a bad debt is more than the actual dollar value lost.
What do I mean?
Consider a bad debt of $1,000. Did you lose only $1,000? Yes, you did lose $1,000, however…
You need to recover that $1,000, right?
Let us say that your business sells computers. On average you sell a computer for $1,000.
The computer costs you $800. You have a Gross Profit of $200 ($1,000 less $800).
To recover that $1,000 lost as a bad debt how many computers do you need to sell?
Five. Yup, gulp, five.
How so? Do the math.
5 computers sold @ $1,000 each = $5,000
The cost of those computers is 5 @ $800 = $4,000
The difference is $1,000, which is your Gross Profit.
This $1,000 bad debt has now been recovered only after selling an additional 5 computers.
So, is the bad debt just $1,000, or $5,000? The bad debt expense is $1,000, that is correct.
However, to get back to where you were before you incurred this $1,000 bad debt you must sell $5,000 worth of computers. Ouch!
9 Principles of Managing Accounts Receivable
- Develop a clear, internal accounts receivable
- Understand your new
- Credit check your new customer
- Mutually agree terms with your customer before delivering goods or services
- Issue the invoice immediately after delivery of goods or services.
- Politely chase your customer before the invoice is due to ensure they are on track for payment.
- Continue politely and persistently chasing your customer for payment if they have not paid by the due date.
- Optional – for truly troublesome customers, go ‘nuclear.’
- Thank your customer for payment as soon as possible after receiving it.
4 Cornerstones of Your Accounts Receivable Procedure
- Schedule invoice chasing time every week.
Book the time out in your calendar in advance. Never cancel it, never miss it.
- Maintain invoice communications histories.
Log all communications with every customer about every invoice. Emails, phone calls, letters, meetings – log it all
We use an innovative program with our clients called Chaser. All communication gets logged in a portal for each customer.
- Regularly assess problem invoices
For larger businesses, this may mean holding credit control meetings. For smaller businesses, this should be covered in regular finance meetings. Always complete bank reconciliation on the day of the meeting to ensure you are working with the most accurate and up to date info.
We stay on top of our bank reconciliations for all our clients daily. For clients who pay by cheque it is critically vital to deposit cheques received within a day.
- Inform the business of bad payers!
If assessing problem invoices reveals customers with poor payment trends, let other departments in your business who have touch points with them know. This may be sales reps or account managers.
4 Questions You Must Ask New Customers
- What information do you need to make payment?
- Who should I speak to in order to settle payment on this invoice?
- When do you make your payment runs?
- What are your business details for invoicing purposes?
By getting answers to these 4 questions, you will avoid:
- Getting paid late.
- Having to re-do invoices, resulting in more internal labor costs.
In Conclusion
The software we use for many of our clients is called Chaser.
Here are some of the key features of Chaser (great name, isn’t it?):
- It will send out personalized emails that fit your style of business.
- It sends these emails in a structured timed way designed to remind your client to pay.
- It will send text messages.
- You can use it to make phone calls and the history of all communication (emails, texts, phone calls) will now reside in one portal inside the Chaser software.
Thanks for reading…
**NOTE this blog post was first published by me in May 2021. I have updated it and am re-publishing it due to the critical nature of good accounts receivable management in an economically challenging time…
by MHolland | Feb 22, 2024 | Accounts Payables, Accounts Receivables, Business Tips, Cash Flow
An often-overlooked ratio to track is a combination of three other ratios…
Once you calculate the other three you simply add the three to get this Turbo Ratio that I recommend all businesses with accounts receivable and inventory track.
So, what is it called?
It is called…
Your Cash Conversion Cycle
It is the measurement of how many days on average it is taking your company to convert sales into cash.
It is the combination of three separate ratios:
- Days Receivable – the number of days on average it takes to collect your accounts receivable.
- Days Inventory – the number of days on average it takes to sell your inventory.
- Days Payable – the number of days on average you take to pay your bills.
Let us go through each of these three ratios…
Your Days Receivable
Here the lower the number of days the faster you are converting your receivables in cash.
You need the following numbers to calculate your days receivable ratio:
- Opening balance of your accounts receivable, at the beginning of the month
- Closing balance of your accounts receivable at the end of the month
- Your monthly sales on credit (non-cash sales)
Add your opening accounts receivable balance to your closing accounts receivable balance and divide by 2.
Take that number and divide by your total credit sales for the month.
Multiply that number by the number of days in the month.
Accounts receivable opening balance = $100,000
Accounts receivable closing balance = $200,000
Average accounts receivable balance = ($100,000 + $200,000)/2 = $150,000
Sales for the month = $300,000
Days in the month = 30
$150,000/$300,000 x 30 = 15 days
Now let us look at the next ratio…
Your Days Inventory
Here as well, a lower number of days is better for your cash-flow.
You need the following numbers to calculate your Days Inventory ratio:
- Opening balance of your inventory, at the beginning of the month
- Closing balance of your inventory, at the end of the month
- Your Cost of Goods Sold for the month.
Add your opening inventory balance to your closing inventory balance and divide by 2.
Take that number and divide by your total Cost of Goods Sold for the month.
Multiply that number by the number of days in the month.
Inventory opening balance = $300,000
Inventory closing balance = $600,000
Average inventory balance = ($300,000 + $600,000)/2 = $450,000
Cost of Goods Sold for the month = $750,000
Days in the month = 30
$450,000/$750,000 x 30 = 18 days
On average it is taking you 18 days to turn your inventory over. In other words, to sell it.
Now let us look at the next ratio…
Your Days Payable
For this ratio, a higher number is better! Why? Because you are taking longer (i.e. more days) to pay your bills on average which means you are preserving cash for a longer period.
You need the following numbers to calculate your days payable ratio:
- Opening balance of your accounts payable, at the beginning of the month
- Closing balance of your accounts payable at the end of the month
- Your monthly Cost of Goods Sold
Add your opening accounts payable balance to your closing accounts payable balance and divide by 2.
Take that number and divide by your total Cost of Goods Sold for the month.
Multiply that number by the number of days in the month.
Accounts payable opening balance = $250,000
Accounts payable closing balance = $350,000
Average accounts payable balance = ($250,000 + $350,000)/2 = $300,000
Cost of goods sold for the month = $900,000
Days in the month = 10
$300,000/$900,000 x 30 = 10 days
Now, let us put it al together…
Your Cash Conversion Cycle
The formula for your cash conversion cycle is:
- Days receivable
- Days inventory
- Less – Days payable
Using our numbers from above we have:
Days receivable = 15 days
Days inventory = 18 days
Days payable = 10 days
Your Cash Conversion Cycle is 15 plus18 minus 10=23 days
Although this is a very crude measurement what it tells you is that on average you will convert your sales into cash in about 23 days.
In Closing
Remember the lower the number the better. Why? Intuitively you will want to convert accounts receivable and inventory to cash as quickly as possible. Less days to do so means cash is hitting your bank account more rapidly.
One other thing to keep in mind is that the Days payable number is more beneficial the higher it is! That is why it is subtracted in the Cash Conversion Cycle Formula.
The longer you take to pay your bills the more cash you have available to run your business. Here you will want to operate with integrity and not take too long to pay your suppliers. After all, they are essentially your partners in your business.
That said, it is fair if you take advantage of longer payment terms and wait as long as possible to pay.
Thank you for reading….
by MHolland | Feb 15, 2024 | Business Tips, Cash Flow
Fixed. Quite the word, isn’t it?
What images does it bring up for you?
For me, it brings up images of unchangeable, immovable, solid, stationary, set.
Fixed costs are necessary. Or at least you thought they were necessary when you incurred them.
And why did you incur them?
To attain a particular result in your business. To achieve something perceived as critically important in your business.
A New Definition of Fixed Costs
A bundle of Fixed Costs are costs of overhead needed to achieve a particular sales volume in your business.
The key is the last part. They are designed to attain a particular level of sales volume.
Unlinked to sales volume, then what exactly are they for?
Unlinked to sales volume, fixed costs have no relevance. They can only be incurred for three reasons:
- Ego gratification. For example, management loves a big, fancy office. The big, fancy office is not needed for sales volume per se.
- You incurred the cost in the past. You no longer need it; you are just trapped inside a fixed agreement like a lease.
- You have not paid any attention to your fixed costs. They just creeped forward on you unawares.
Here is a remarkably simple, personal example of “unlinked to a result” fixed costs.
Imagine you have a goal – to get fit.
You join a gym. You go for a while. Then you buy a home gym. You stop going to the gym. You continue to pay. (You are locked into a contract. You are just not thinking about it).
The fixed gym membership fee is now “unlinked” to your goal. It is an irrelevant cost.
A few of these and you have massive, fixed cost creep, and diminished or disconnected results.
Re-Thinking Your Bundle of Fixed Costs
On your Profit and Loss Statement there are three main categories.
Sales, Cost of Goods Sold, and Overhead (comprised of mostly fixed costs).
Sales less Cost of Goods equals your Gross Profit.
Your Gross Profit must cover your Fixed Costs plus your expected or desired Net Profit.
Start to think of your business, or any business, like this….
Take your Gross Profit percentage and divide it by your total Overhead (Fixed Costs) plus your desired profit and you will arrive at your required sales volume.
Now, here is the switch I want you to make in your thinking.
Think of your bundle (or group) of Fixed Costs as related to the capacity of volume your business must attain to break even and make a profit.
An Analogy
To make it clearer – think of this bundle of Fixed Costs like a machine.
You lease a machine. That is your fixed cost. The machine has a fixed, maximum capacity. It can produce so many widgets and that is it. You can determine what that is by the output per hour, as a simplified example.
Now it gets a bit tricky. Unlike a machine, your fixed costs are comprised of a group of expenses related to your sales volume capacity.
Some of those expenses will be non-contributors. They are no longer value contributors to your sales volume.
A Step-By Step Breakdown
Let us say you have $50,000 in monthly fixed costs.
Your Gross Profit Margin is 40%.
You desire a Net Profit of $20,000 per month.
Take the $50,000 and add the Planned Net Profit. You get $70,000 ($50,000 plus $20,000).
Divide that by the Gross Profit Margin of 40% and you have a required Sales Volume of $175,000 ($70,000/40% = $175,000).
Here is a simple re-work:
Sales $175,000
Cost of Goods Sold (60%) (105,000)
Gross Margin – 40% 70,000
Fixed Costs 50,000
Net Profit $20,000
You sell one product at $10 each. Your break-even sales volume is 17,500 units ($175,000/$10 per unit) = 17,500 units).
Okay, so now you can think of your Fixed Costs as having to produce (like a machine) 17,500 units.
Three Crucial Questions
Now in examining your Fixed Costs bundle with this latest information related to capacity, you must ask yourself these questions:
- Is my business capable of producing 17,500 units, with this bundle of costs?
- Is my business not capable of producing 17,500 units with this particular bundle of costs?
- Is my business capable of producing 17,500 units, yet could do so much more efficiently?
Now, go through each expense and ask these two questions:
- Is this cost necessary to produce my required volume of 17,500 units? If not, kill it if possible.
- Is this cost necessary, yet too high? If yes, try to renegotiate contracts or find new suppliers with less cost for this expense.
Convert Fixed Expenses to Variable
The best approach for managing capacity and for growth is convert Fixed Costs to Variable Costs.
How to do that?
Ask more questions:
- Do you need an office at all? Can your team work from home as effectively? Can you downsize your space? Or sub-lease?
- Can you convert employees (usually your biggest expense) to part-time employees? Can you outsource the work done by employees? That would convert that large expense to a variable one.
- Can telephone contracts be renegotiated?
- Can you partner with suppliers to pay them a volume type incentive rather than a fixed fee?
In Conclusion
Finally, remember to review your Fixed Costs on a frequent basis, even monthly.
A closing example is looking at software costs. These can get sticky. Often, we pay for needed software as a service. We stop using it, and we forget to cancel. So, it is a good idea to at least review these types of sticky costs monthly.
Thank you for reading…
by MHolland | Jan 31, 2024 | Business Tips, Cash Flow
Accountants should not be responsible for setting pricing.
Why not, you ask?
Because most accountants will focus on all your costs (inputs) and add an acceptable mark-up to get to the price.
Here is the problem – customers do not care what your costs are. Why should they? You could be running a very inefficient business with wages that are too high, rent that is too high, and so on.
Costs Do Not Equal Value
Let us look at a car example. It likely costs more to build a Mercedes than a Ford Fusion. Yet, not that much more. In other words, the mark-up on the Mercedes is greater than on the Ford Fusion for the intangible value that the customer places on that 3-star symbol on the hood.
In today’s outsourced manufacturing environment how does a business add value in unique ways to get a higher price?
It seems like everything is a commodity these days. How do you do value pricing when you are selling a commodity?
See It Through the Eyes of Your Customer
This is where, again, you must look at your product/service through the eyes of your customer.
Ask these questions:
- What elements of your product/service does your customer value?
- For example, can you deliver the commodity you sell more quickly than your competitors?
- What about after-market service? When the commodity product breaks down, what does your customer do? What expectations do they have? You could offer awesome after-market service for a price. You could build it into the initial pricing.
- What is a frustration that ALL customers have in your industry? It could be delivery times. No after-market service. Slow service. Indifferent, non-caring attitudes from order takers. Solve this big problem everyone has, and you are now differentiated. You will stand out from the crowd.
- What can be bundled with your “commodity” to add value and create something unique?
An Example of Fixing an Industry Wide Problem
In the accounting industry almost, everyone charges by the hour.
So, the client never knows what the ultimate bill will be until the work is done. All the risk is borne by the customer.
Most clients hate hourly billing. They hate it because they never know what they will pay.
This is where Fixed Pricing comes in. You work out what the value is to the client for the work to be performed and then set that price. You get the client to sign that agreement. The client will then hold you accountable for the results that you are committed to deliver.
All the risk is borne by the seller now. If you are inefficient, you will make less profit. Conversely, the rewards are all with you as the seller now too. If you take less time to fulfill on the promised results, then you will have more profit. (The client does not care; they agree to a Fixed Price and the inputs are not relevant).
Fixed Price Agreements transform something that most clients find annoying, irritating, or downright unfair into a competitive advantage.
How To Turn a Commodity into a Rarity
Again, let us again use the accounting industry as an example…
A tax return could be seen as a commodity now. It is just entering your slips into a tax software program, and the result is spit out and you either pay tax or get a refund. End of story.
The cheaper the tax return the more you save.
Why would you pay more? Where is the value add?
Okay, this is where bundling can come in handy.
You look at all the services you offer as an accounting firm – wealth planning, and retirement planning as two examples.
You create a bundle of services that includes:
- Retirement planning
- Guaranteed tax return. If the IRS or CRA sends any correspondence to you regarding your tax return that year you will handle it free of charge. In other words, audit insurance.
- You provide free phone calls on any tax matter coming up during the year.
As an example, let us imagine that the tax return is only worth $75. However, the entire bundle mentioned above is worth $1,000. Not all the clients of the firm will pay that. Many will, and the profitability could be much, much higher.
The above example could apply to most professional service firms, and even blue-collar industries like electricity and plumbing.
For example, a plumber could charge a fixed maintenance fee to cover a set of deliverables including annual maintenance that many people would happily pay extra for.
In Closing
Think about, in your industry, a problem that everyone has with your industry. (You may need to ask your customers). Solve that problem and change your prices accordingly.
Lastly, think of how you can use the concept of bundling to add value and increase your pricing for a bundle. Insurance or guarantees are a great way to add value.
Thanks for reading…
by MHolland | Jan 13, 2021 | Cash Flow
Last week I wrote about the early yardage predictor of cash-flow.
Do you remember? It is the estimated dollar figure of what is in your sales pipeline. And there is the timing aspect. This is the time it takes from connecting with a prospect to closing a sale.
This week we will look at what I call the back-end timing.
Now we look to the future. We look at one grand Key Performance Indicator. It is made up of 3 parts.
Let us take a look at…
What is Your Cash Conversion Cycle?
In a perfect business you have no accounts receivable, no inventory, and you pay your vendors later!
This translates to – you make a sale, and the cash goes into your bank right away.
Imagine you pay your suppliers in 30 days. Wow! Perfect, right? You get the money right away and pay your vendors later.
For most businesses, this is not how it works.
Why not?
Because for most businesses, you have accounts receivable, inventory to sell and accounts payable to pay.
Most businesses have money tied up in accounts receivable (money owed to you). Then there is a lot of cash invested in inventory for others.
The third number is favorable to you – paying your vendors later helps preserve cash!
Let us take a look now at what makes up the calculation of your cash conversion cycle…
Cash Conversion is Made Up of 3 Numbers
Three things make up your cash conversion cycle:
- The days on average it takes to collect your accounts receivable, plus,
- The days on average it takes to sell your inventory
- Less the days on average you take to pay vendors
Let us say it takes you an average of 27 days to collect your accounts receivable (amounts owed to you).
It also takes an average of 18 days to sell your inventory on hand.
You take 21 days to pay your vendors.
Your cash conversion cycle is simply the sum of the first two numbers less the 3rd number.
In this example, you add 27 days to 18 days, and you get 45 days. You subtract 21 days that you take to pay your vendors for the final number of 24 days.
Your cash conversion cycle is 24 days.
This is an estimated number and not a hard number. Each number is an average and it is based on the past.
Anything changes and boom, so does the number.
What Should Your Goal Be?
The trick to improve your cash conversion cycle is to get paid quicker from your customers, sell your stock on hand faster, and pay your vendors a bit more slowly.
Here is an interesting question…
Can you ever have a negative cash conversion cycle?
Yes!
Here, “negative” is great!
For instance, you get paid upfront for most sales, so your Days Receivable is just 3 days. You turn your inventory over super fast in 9 days. You pay your suppliers in 21 days.
So, let us do the math. Three plus nine equals twelve. Twelve minus twenty-one equals what? Negative 9.
This would be a ridiculously awesome business to have, provided it is profitable. It would always be cash-flow positive!
Thanks for reading…
by MHolland | Jan 6, 2021 | Cash Flow
Timing.
And timing has two aspects to it.
The first is the timing of the prospects in your pipeline.
What is the best early indicator of your cash? The value of the interested prospects in your sales pipeline. I will show you how to get that figure.
Firstly, we will look at the numbers.
Number 1 – Possible Prospects in Your Pipeline
At the top of your pipeline are all the possible customers/clients.
This number shifts based on economics. For instance, imagine you own a restaurant. The number of potential customers eating out – in a pandemic – goes down. (And you can seat way less too).
However, the number of people eating at home (and not traveling) goes up!
You need to pivot fast. You must get home deliveries going. Then find creative ways to market to these “eating at home” customers.
The first number are the total possible clients in your area, for your business.
What is next?
Number 2 – The Number of Actual Prospects in Your Pipeline
Now you need a hard number. Who have you been in contact with?
This could be number of prospects reached through social media, direct mail, print advertising, and radio as examples.
This number is the top of your funnel.
We will go through an example…
You own a technology business. To reach a prospect you decide to run an email campaign.
Next, and this is critically important. You need to define and refine your Number 1 above – the number of potential clients for you.
Perhaps everyone could use some aspect of your technology services. That number is too big. You realize you have expertise in, say, non-profits and charities.
Great! Now get more specific. You want the ones of a certain size. It could be based on sales, or in this case, total revenue from donations. Or it could be employee size.
You buy a list of all organizations in your targeted niche from a company like InfoCanada.
Now you start connecting, and connecting, and connecting.
You see, you have to find out how many contact points it will take, on average before one of two things happen. (1) you reach a natural dead-end, or (2) you obtain a new client.
In other words, how many emails – three, maybe four – followed up with a phone call before you stop or convert.
Which leads to the third number…
Number 3 – Your Conversion Rate
How many people in your pipeline are pondering becoming your client?
There are actually two conversion rates here. The first is – the percentage of prospects who went from a name on a list to actually engaging with you.
The final conversion rate is the percentage of clients looking who become clients.
I will show you how this works:
Conversion rate #1
- Number of names purchased to email to – 1,000
- Number of prospects who looked at your offering – 300
Conversion rate number one – 30% (300/1,000)
Conversion rate #2
- Number of prospects who looked at your offering – 300
- Number of prospects who sign up – 50
Conversion rate number two – 17% (50/300)
Each tells a different story. Number 1 tells you how effective you are reaching the right audience. Number two tells you how good you are at converting an interested prospect to a paying client.
As in Comedy, Timing is Everything
Knowing the length of time, it takes for a name on a list to become a client is critical.
With it you can calculate the value of your sales pipeline at any point in time.
This is known as your sales cycle timing. It varies from industry to industry. A general rule of thumb is that the higher the value of what you are selling, the longer the sales cycle. It can even be years in some cases.
Before you get to the final number, you must know one more number. Your average sale!
Now you can create a cash-flow forecast with that solid dollar value of projected sales. You multiple the average dollar value of a sale, by the expected number of clients. You place that dollar value into the future month based on your average sales cycle.
Then you test, measure and tweak.
In Summary
Next week, I will write about the second aspect that affects your cash-flow timing.
Thanks for reading…
