Sunday, July 1, 2007

Do Unto Your Vendors as You Would Have Your Customers Do Unto You

In the short and long-term, your business will benefit greatly by paying your vendors the way you want to be paid by your customers.

Customers who pay early will, over time, receive the highest quality and best service and price offered by their vendors. Do you respond more quickly and intently when your quickest paying customer presents problems with your product or service? Are you more willing to think outside of your normal operating procedures to help solve that customer's problems? If you have any responsibility for the cash flow of your business, then your answer would probably be YES!

Anecdotal and empirical research suggests the same conclusion - you will receive additional benefits in the long run from your vendors if you pay them quickly. How would your vendors classify your payment timeline? Are your payment policies getting your business more or less from your vendors? Regardless of your answers, consider the potential short-term impact of an early payment policy.

If you currently spend $100,000/month with a vendor, and you typically pay them in 40-days, it may be worth a lot to that vendor if you accelerate your payment cycle to just 10-days. In fact, for this example, let's assume your vendor offers a 2% discount for doing so. Would the 2% discount be worth tying up your cash by paying down your accounts payable by $100,000 to get your company in-line to pay for all of your purchases with that vendor within 10 days?

Assuming your cash flow from operations can keep you at or below 10 days with this vendor for the next 12 months, and assuming that you borrow from your line-of-credit (12% interest per year) to make the one-time catch-up payment of $100,000, let's see if your business will receive any economic benefit. You will receive a total discount on your purchases with the vendor of $24,000 ($1.2 million in annual purchases times 2%) and you will pay $12,000 ($100,000 at 12% per annum) in interest to cover the one-time payment. All other things being equal, this means you will actually net a $12,000 gain by accepting their offer of a payment discount. You don't have to hire a CFO figure out the advantages of this scenario.

Whether or not you have the option to use advantageous early-pay discount terms with your vendors and suppliers, your business will still benefit in the short and long-term from a strategy to be one of their best paying customers.

With a weekly cash flow report produced by your internal bookkeeper, accountant, or controller, you should be able to determine how and when to speed-up your payments to your vendors. This will inevitably improve your business relationship with your vendors. Without a weekly cash flow report, it may be very difficult for you to have any type of strategy to receive the highest quality and the best service and prices from your vendors. A well-planned and executed cash management and finance strategy will allow you to truly partner with your vendors to gain a significant and sustainable competitive advantage. If you do unto your vendors as you would have your customers do unto you, you will receive short-term benefits and long-term rewards!