Would you prefer to get paid today rather than Net30? Of course! Positive cash flow funds your operations and growth. Amazon is a shining example of how powerful it can be. And on the flip-side, it is well researched that the lack of working capital is the main reason for bankruptcies. Receipt of cash is the fuel of a business so each of us should make time-to-cash a priority. But how big a priority? What is the impact of time on cash, profits, and valuation? Does time really equal money? Yes!
As companies, we extend credit in the form of payment terms that define timing, payment method, and other criteria. Most of our practices are based on pre-digital approaches, established while using the postal network. Consequently as suppliers, we extend credit based on invoicing, collections, and cash application that is antiquated and slow. (See my previous post about antiquated terms.)
How much do antiquated receivables costs? You can calculate it easily. The time cost of deliverables is the interest per day the cash would impact your company multiplied by the average days to collect the cash (days sales outstanding or DSO). The numbers you need are your annual receivables amount, average DSO, and an interest rate, e.g., prime rate or line of credit.
The time cost of receivables is calculated as follows:
time cost = (annual receivables * interest rate)*DSO/365
For individual companies, how does that add up? Well if a company is $50M in revenue, the time cost is $337k. For $100M, it 674k. At $500M, it is $3.7M. And at $2.5B, time cost is $16.85M.
What was the time cost in 2017 for the United States? Over $60 billion dollars. The US had a GDP of $19.38T of which 45.5% was sold on credit with an average DSO of 61 days and an average prime rate of about 4.1%. Using the equation from above:
$60.4B = ($19.38T * 45.5% * 4.1%) * 61/365
So yes, DSO proves that time does equal money. The time needed to collect receivables is real money and real opportunity cost. The time cost of receivables could be investment into personnel, capital to grow, or profits to shareholders. Reducing DSO, even a little bit, can have a significant impact on cash flow and profitability. Accounts receivable optimization does exactly that. To reduce the time and cost of getting paid, you should be ensuring:
At Globys, we are working on solutions to shrink DSO. Follow me on LinkedIn and our company blog for more about accounts receivable optimization.
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