Top organizations relentlessly bang the drum about the importance of customer service. But there is one area in business where doing your clients a “favor” can prove extremely harmful to your bottom line, and even hurt your clients down the road.The best way to illustrate this, as is usually the case, is via a case study.
My team was analyzing the finances of a client, reading between the balance sheets (so to speak) to find any issues that needed to be addressed. As you’d expect, we found a big problem. Big, but not uncommon.
The client was allowing many of his clients to not pay their bills beyond 30 days. On average, his clients were 13 days past due.
He thought he was doing them a favor. Being a nice guy. You know, the customer service thing.
We asked him if realized he was acting like a bank; basically handing out loans to his clients. He said he knew, but that it didn’t bother him. He had good clients, and he knew they would pay.
He was right – eventually, his client would pay. But in interim, he was also paying big time. Over the course of the year, this casual approach to his accounts receivable was the equivalent of making no-interest loans to his customers that totaled $100,136!
Sound crazy? Check the math. He had accounts receivable of $850,000, and his clients were 13 days past due, on average. The formula to show how much he loaned out: (30+13)/365*850,000= 100,136.
That’s money he could have used during the course of the year. Money to buy new equipment, pay bills, invest in training…and most importantly, grow his sales.
The Importance of Your Current Ratio
Without a doubt, you’re going to have some clients who pay late. That’s part of doing business. But when do you slip into the danger zone and start acting like a bank?
To answer that, you need a crash-course in “Financial Ratios 101 – Current Ratio.”
The client I mentioned above had an imbalance of cash to receivables. Every year, his accounts receivable were more than his cash equivalents. This is measured in a financial ratio called the Current Ratio.
Current Ratio measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm’s current assets to its current liabilities. The current ratio is an indication of a firm’s market liquidity.
If your firm’s current ratio is around 2.3, then you generally have good short-term financial strength. If you’re below 1, then you’re going to find yourself having problems meeting short-term obligations.
Note that’s a general statement – there are actually specific medians in the printing industry, which serve as effective benchmarks. (If you’re interested in learning more about these industry-specific ratios, please contact me.)
You need to get your current ratio in line, otherwise you lose out on what’s called the “use of money.”
How the Use of Your Money Affects Your Business
True to its name, “use of money” in this case means you don’t get to use the money – your client does.
Think about it this way: If that client had found a $100,000 piece of equipment that would have been critical to his business, he’d have to go to the bank to finance it. And what do you think the bank would do? Naturally, it would charge him interest – a cost he wouldn’t have to pay if he would have kept his accounts receivable in line.
The impact doesn’t stop there, however. What’s truly debilitating is your ability to expand sales.
Your natural inclination as a business owner is to take business whenever it walks through the door. A new client comes in, orders $3 million in new business, and you take it. You have to, right? You’d be a fool not to, right?
That all depends on whether you’ve got the capital on hand to handle all the new costs that come with extra business. More resources, more personnel, more expenses.
Not only will you need adequate capital to take on the new business, but your accounts receivable must be monitored so you can afford the new costs. The larger you get, the more impact this will have.
Your sales people could be doing a great job getting orders and business, but if your company can’t keep up with them and is losing money on the financing of the new business, then the new business won’t be around for long. Neither will the sales person.
We tell our clients this all the time. Funny how the ones that understand always turn out to be more successful than the ones who don’t.
How to Get Paid and Deliver Great Customer Service
Remember, my client did not want to ask his clients for payment. I think he felt this was a cost of doing business, and that he would be viewed as a preferred vendor because he cut his clients some slack.
The truth is, he was doing his clients a huge disservice. By preventing his own business from growing faster, his company couldn’t realize its true potential and perform as effectively for its clients as it should.
Here are some ideas for getting your accounts receivable (AR) on track:
- Offer a discount for early payment. You may think about penalizing a company for paying late, but that gets a little dicey. Instead, why not offer a discount for early payment? By offering a discount of 1% net 15 days or 2% net 10 days, your client saves and you get money in your pocket sooner. It’s a tremendous win-win situation.
- Reason with your clients when they ask for new orders. When you’re making a sales call and a client wants to order more materials, let them know that you can’t provide them with anything until you’ve been paid. It’s a reasonable request that any businessperson should understand. Someone may have been hoping you wouldn’t say anything, but they won’t think badly of you if you ask for the money you’re rightly entitled to receive.
- Monitor your AR carefully. Chances are your accountant will break out in a big smile if you ask about monitoring AR carefully. Stay on top of this, as you’ll quickly identify who the great clients are. You’ll also know when you have money to expand your business.
I hope that you’ll understand just how critical proper monitoring of your AR can be. Remember, you’re not doing any favors to your client in the long haul by shortchanging your own company. Monitor your accounts receivable and get payment promptly, and then all boats will rise.
Photo by: 401(K) 2012