I was teaching my senior level college finance class a few years ago and really discovered the power of quick pay discounts. I was teaching the class the basic formula outlined in the textbook:
We did a couple problems and moved on.
When we were reviewing the material for the test, someone asked me a question on quick pay discounts, and I explained it differently.
I took basic vendor terms of 2%10, net 30 terms. I went through the math (.02 ÷.98) x (360 ÷ 20) and calculated 36.73% - the cost of not taking the discount.
We discussed the math and simplified saying you figure out how many 20 day periods there are in a year (365/20=18.25) and multiply that by 2% = .365 or 36.5%. I used 365 days in a year vs. the text book’s 360. That’s when it hit me. I can make 2% 18.25 times per year - assuming you pay the vendors exactly at 30 days, in this example.
That’s a lot of extra margin - by paying vendors 30 days instead of 10, I make 36.5%. If I borrow the money at 8%, I still make a net 28+%.
Think about it - what’s your gross margin on your sales?
By using purchase discounts effectively, you can double your gross margin – how’s that for adding profit!
Tuesday, November 30, 2010
Tuesday, November 02, 2010
60 Days Left
Trick or Treat – only 60 days left to the end of the year.
It’s hard to believe there is less than 60 days left to the end of the year. Time does go fast.
If you’re like me, you base goals – personal and business, and business plan results on the end of the calendar year. If so, it’s time to kick the goals in high gear with a big push to end the year - and start planning for 2011.
It’s also time to get your team committed to the same.
I did this at October 1st – planned the last 90 days. I pulled out my goals and business plans – took out a calendar – reassessed some targets – and developed a 90 day plan with actionable targets. I have reviewed and updated the plan weekly since. You know what? I was able to get a few priority things back on track.
For me, I had accomplished some of the things I set out to do in 2010, but others had lost priority and slipped out of sight. This re-engagement at 90 days reprioritized everything, and created focus and urgency. My business picked up, and I feel better about myself.
If you haven’t re-assessed your 2010 goals and business plans, do it now – you have 60 days left. It’s late, but you can get a lot done in 60 days. It is amazing to how a daily focus with a short time frame helps get the important stuff done.
It’s hard to believe there is less than 60 days left to the end of the year. Time does go fast.
If you’re like me, you base goals – personal and business, and business plan results on the end of the calendar year. If so, it’s time to kick the goals in high gear with a big push to end the year - and start planning for 2011.
It’s also time to get your team committed to the same.
I did this at October 1st – planned the last 90 days. I pulled out my goals and business plans – took out a calendar – reassessed some targets – and developed a 90 day plan with actionable targets. I have reviewed and updated the plan weekly since. You know what? I was able to get a few priority things back on track.
For me, I had accomplished some of the things I set out to do in 2010, but others had lost priority and slipped out of sight. This re-engagement at 90 days reprioritized everything, and created focus and urgency. My business picked up, and I feel better about myself.
If you haven’t re-assessed your 2010 goals and business plans, do it now – you have 60 days left. It’s late, but you can get a lot done in 60 days. It is amazing to how a daily focus with a short time frame helps get the important stuff done.
Tuesday, October 05, 2010
Up Your Cash
We see many businesses that are growing profitability, but are having difficulty continuing their growth specifically due to the lack of cash. You’ve heard the expression ‘cash is king’, well it is true.
Several things can be done to ensure this does not happen to you. Even if you are growing profitably and you have enough financial resources to fund the growth, improvements in cash flow will enhance your profitability with the ability to pay down debt or take advantage of vendor discounts.
The following are the 7 best ways to enhance your business’s cash flow:
1. Negotiate better terms with your vendors – payment terms of 40 days vs. 30 days significantly enhances cash flow – a business with vendor related costs of $14m that extends the average days to pay from 30 to 40 days enhances cash flow by $400,000!
2. Get some cash down up front - This is a great way to have your clients fund the projects not you.
3. Be careful with your payment terms with customers – balance due on completion is much better than 30 day terms. If you do extend credit terms, be diligent in your collection practices. Even slight improvements in day’s sales outstanding (DSO) can be a significant enhancement to cash flow. If you are a $20mm business with $2.2mm in accounts receivable, a 5-day improvement means a $274,000 incremental increase in cash flow.
4. Manage your inventory better – the same principal as DSO and average days to pay applies to days of inventory on hand. Any improvement here has serious implications to improve cash flow.
5. Watch your operating expenses. For most businesses, the most significant operating expense is payroll and payroll related cost, but carefully watching all expenses is imperative. Any improvement directly enhances cash flow.
6. Use a line of credit at the bank to plug any shortfall of cash flow and allow you to take advantage of vendor programs
7. Watch what you take out of the business. Shareholders use the business to pay business related and other expenses, but anything you take out directly reduces cash.
Additional cash generated by using the above techniques can be used to grow the business, to paydown debt, or to take advantage of quick pay vendor discounts. Remember taking advantage of quick pay discounts is an excellent way to leverage your cash flow to enhance profitability. Taking advantage of a 2%10, net 30 discount returns approximately 37% – so it may make sense to tap your line of credit occasionally to take advantage of the vendor discount.
Use the following formula to calculate the cost of not taking a discount.
Cost of failing = Discount % X 360
to take discount 100% - Discount % Final due date - Discount period
So, in the 2%10, net 30 example above .02/.98x360/20 = 37% - That’s a lot to give up by paying in 30 days instead of 10.
Several things can be done to ensure this does not happen to you. Even if you are growing profitably and you have enough financial resources to fund the growth, improvements in cash flow will enhance your profitability with the ability to pay down debt or take advantage of vendor discounts.
The following are the 7 best ways to enhance your business’s cash flow:
1. Negotiate better terms with your vendors – payment terms of 40 days vs. 30 days significantly enhances cash flow – a business with vendor related costs of $14m that extends the average days to pay from 30 to 40 days enhances cash flow by $400,000!
2. Get some cash down up front - This is a great way to have your clients fund the projects not you.
3. Be careful with your payment terms with customers – balance due on completion is much better than 30 day terms. If you do extend credit terms, be diligent in your collection practices. Even slight improvements in day’s sales outstanding (DSO) can be a significant enhancement to cash flow. If you are a $20mm business with $2.2mm in accounts receivable, a 5-day improvement means a $274,000 incremental increase in cash flow.
4. Manage your inventory better – the same principal as DSO and average days to pay applies to days of inventory on hand. Any improvement here has serious implications to improve cash flow.
5. Watch your operating expenses. For most businesses, the most significant operating expense is payroll and payroll related cost, but carefully watching all expenses is imperative. Any improvement directly enhances cash flow.
6. Use a line of credit at the bank to plug any shortfall of cash flow and allow you to take advantage of vendor programs
7. Watch what you take out of the business. Shareholders use the business to pay business related and other expenses, but anything you take out directly reduces cash.
Additional cash generated by using the above techniques can be used to grow the business, to paydown debt, or to take advantage of quick pay vendor discounts. Remember taking advantage of quick pay discounts is an excellent way to leverage your cash flow to enhance profitability. Taking advantage of a 2%10, net 30 discount returns approximately 37% – so it may make sense to tap your line of credit occasionally to take advantage of the vendor discount.
Use the following formula to calculate the cost of not taking a discount.
Cost of failing = Discount % X 360
to take discount 100% - Discount % Final due date - Discount period
So, in the 2%10, net 30 example above .02/.98x360/20 = 37% - That’s a lot to give up by paying in 30 days instead of 10.
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