Talking Cents

The relationship between trading terms and your small business cashflow

“A ship without a rudder is destined to run aground eventually.“

All small business owners need at least a basic understanding of their business financials to know exactly how their business is performing. Key goals must be set and then performance tracked to ensure your business is on target to achieve what you want out of it.

For businesses that rely on generating sales invoices on account and extending payment terms to their customers, it is just not good enough to say that you’ve met your sales target for the month if all your customers take a month of Sundays to pay you. You end up running out of cash very quickly if such circumstances exist. A key accounting ratio is called “Debtor Days”. It’s very easy to measure and consists of total debtors at a point in time divided by total turnover divided by 365, expressed as:-

Average debtor days = debtors / turnover X 365.

Why does this matter? I hear you ask. The longer customers take to pay, the worse your cash flow gets. A business with poor cash flow will soon run out of cash. Customers are “allowed” to pay late because you didn’t chase them up and they will get used to it then take advantage of you. Your ability to pay your own expenses is severely restricted and will give you a poor reputation with your suppliers.

What can I do? Express your trading terms as clearly as possible up front before the work is done. Make sure your trading terms are on your invoice in clear text. Have a procedure in place for contacting late payers to continually follow them up until the debt is paid. Follow that procedure! Consider not doing any more work for clients that consistently pay late and replace them with clients that pay on time.

Many businesses in Sydney and Melbourne make a profit on paper but end up closing down due to a lack of cash in the business, don’t fall into this trap, and start monitoring your cash. It’s your money and your entitled to be paid for your blood, sweat and tears.