Many business owners complain of cash flow problems. However, a few companies actually have the opposite situation. They have excellent cash flow. In fact, they have more cash than they need to run their everyday operations. This scenario provides a great opportunity to increase profits.
Companies with excess cash flow can use it to increase the company’s profitability by paying some invoices quickly. This article explains how to take advantage of this benefit strategically. We cover:
- Common uses for excess cash flow
- Consider paying some suppliers quickly
- One additional benefit
- Use the strategy carefully
1. Common uses for excess cash flow
Having excess cash flow is a tremendous competitive advantage, especially if you use the funds strategically. The easiest and safest approach is to keep the funds in a bank account and earn some interest. Putting all your excess cash flow in a bank account is a reliable and conservative strategy. It’s tried and true and works well.
However, keeping all the funds in the bank is not always the best approach. You may be able to use some of those funds to increase your company’s profits by paying some suppliers early. If done correctly, this strategy can be an effective use of your excess cash.
2. Consider paying some suppliers quickly
Let’s look at a typical commercial sale transaction. Commercial clients usually pay their suppliers on terms. If you are the client, these terms give your company 30 to 60 days to pay its invoices. Getting terms from suppliers is great for your company since it improves your cash flow.
Now, let’s look at the supplier side of the transaction. For a vendor, offering terms and waiting 30 days for payment can create cash flow problems if a company is not well capitalized. Many vendors try to improve their cash flow by offering their clients an early payment discount. The discount averages 2% if the client pays an invoice within ten days.
Companies with strong cash flows and a well-funded cash reserve should consider taking advantage of these supplier discounts. Paying these invoices early gives you a discount that drops straight to your bottom line as extra profit. Basically, you improve your profits by using your cash flow more effectively. If done correctly, these savings come at no extra cost.
Not all vendors “advertise” their early payment discount incentives. Some offer them only if asked. Consider contacting vendors that don’t openly offer early payment discounts and inquire if they are interested. Many companies are happy to provide a discount if you pay quickly.
3. One additional benefit
One additional benefit of this approach is that it can also improve business credit. Improving your business credit can give you access to higher vendor credit lines or longer payment terms in the future. Again, it’s a matter of paying your suppliers early but selectively.
Find out which of your suppliers that are offering an early payment discount also report payment information to Dun & Bradstreet or similar credit bureaus. These credit bureaus collect information and are used by companies to determine which clients get trade credit. It’s to your company’s advantage to prioritize payments to suppliers that report information to credit bureaus. These fast payments can help improve your company’s credit profile while also improving your profits.
Vendors use your company’s business credit profile to make credit decisions. Improving your profile can help increase your future access to business credit.
One important point. Regardless of who you pay early, make sure you pay all your vendors on time. It is a good business strategy, a way to build a good reputation, and the right way to operate a business.
4. Use this strategy carefully
You should pay suppliers early only if you have good financial controls and have an accurate view of your cash flow. Also, don’t use this strategy unless you have built a solid emergency cash reserve. Otherwise, you risk having cash flow problems yourself.
Keep in mind that cash flow can change daily. A business with good cash flow can quickly find itself in trouble if circumstances change. The last thing you want is to pay suppliers early only to end up with cash flow problems yourself. Consequently, always keep your accounting system up to date. Review your cash flow statements regularly and monitor your bank account regularly. Stop making early payments and revert to normal payments if your cash flow changes or if you must use your emergency cash reserve.
Lastly, consult a CPA if you need specific advice on how to keep your accounting system up to date or monitor cash flow.