Success to the bottom line of your business not only requires increased sales, thicker profit margins, and cutting the business's costs as much as possible, but it also means using your cash effectively. One method to save money on accounts payable and take advantage of the Time Value of Money concept is by delaying payments to your vendors without damaging the relationship.
If you are a business that regularly has to buy inventory, or for any expense for that matter, you generally have terms on your accounts paayable. For example, a vendor may give you 30, 45, 60 or more days to pay for the inventory from the date of receipt.
As a business, do you think you should pay the vendor immediately upon receipt?
It may give you a fuzzy feeling to get rid of bills, but the answer is no!
Saving Money On Vendor Payments
If a vendor is going to give you 60 days to pay for the goods that you received and are able to generate sales from those goods immediately, you pay the accounts payable on the 60th day, plain and simple.
Let's take it a step further, unless you are unable to pay off a credit card every month and it's going to get you in trouble with your business's finances, then you should be using your credit card to pay your accounts payable. Note...if you are having trouble getting your credit card balances down, please make sure to visit the Paycheck Parking article.
Think about what we just did. We delayed payment to the vendor for 60 days, we then paid the vendor with our credit card which is not due for another 30 days. A total of 90 days to be able to turn that inventory into cash!
Imagine that you are starting a business and purchase $50,000 of inventory and are able to turn that inventory into sales within 30 days. You know that you are going to be able to put a 200% margin on the inventory which produces net sales of $100,000 every month. Each month you duplicate the same purchase and sales.
Notice that for the first two months, there are no vendor payments for the inventory because we delayed vendor payments for a total of 90 days, therefore our actual payment for the first $50,000 in inventory doesn't actually leave our cash balance until sometime in the third month.
What's really interesting is to notice how our cash built over 4 months on the profit line just by delaying vendor payments to the max that we could. Essentially this simple principle to save money allowed the business to build into a sprint very quickly!
One last thing, we are being extended grace from our vendors by allowing us to pay for what we owe, some days into the future. With that said, don't damage the vendor relationship by paying farther out than what is allowed.
Time Value of Money
If you continue to repeat this process of delaying vendor payments, you end up taking advantage of the The Time Value of Money (TVM) principle.
The Time Value of Money is the concept that a sum of money is worth more now than the same sum will be at a future date due to its earnings potential in the meantime. The time value of money is a core principle of finance. Basically, a dollar in my pocket now is worth more than a dollar in my pocket a month from now. Point is, we want to hold on to cash as long as possible and push out our expenses.
These two simple notions can really help the cash flow of your business and, if you are thinking about starting your own business, I challenge you to think about the head start that they can afford your ability to get started. Go for it!
Blue Collar CFO