Effective management of operational cash is integral for the success of any company. Every business owner should know how cash flows into and out of his organisation, unfortunately many business owners find themselves bogged down by day to day business operations and often leave the money bit to their finance department or receivables management services. While your finance department may definitely understand managing finances better than you, you are the owner of the business. It doesn’t do you or your business any good if you don’t have a basic understanding of your finances. The first step to understanding your company’s finances is to understand Accounts Payable, Accounts Receivable and related elements.
Accounts Payable is the money that a business or organisation, in this case, you, owe another individual or company for purchased goods or services rendered on credit. It could be rent to be paid for office space or rented office equipment, or money owed to your IT service provider. Also known as AP, Accounts Payable is a liability.
Accounts Receivable is money that is owed to you by individuals or companies for goods purchased or services rendered. Understandably, unlike Accounts Payable, Accounts Receivable, or AR, is an asset.
For a business to run successfully, it is important that a balance be maintained between AR and AP. This is simply because at any point of time, it is crucial that a business has sufficient cash in hand to keep the business running. This is also referred to as positive net working capital, where working capital is essentially the difference between assets and liabilities at a given point of time. A positive working capital can only be achieved if your business collects payment timely and settles pay outs effectively.
Day Sales Outstanding (DSO) and Day Payable Outstanding (DPO)
DSO refers to the average number of days AR payments are collected. Receivables management services state that a DSO of less than 45 days is needed to manage working capital effectively. DPO refers to the average number of days it takes your business to clear an AP payment.
Increasing Working Capital
Since we have established why it is important to maintain a positive working capital, the next question is how do you effectively do this. The answer is quite simple- reduce DSO and increase DPO or collects AR payments faster and delay AP payments. Unfortunately, implementing this is not as easy, simply because no one likes a business that delays payments and no one likes businesses that rush collecting payments. Now you don’t want to become the business that no one likes; which is where receivables management services can help you.
Business owners have found that outsourcing AP and AR management to receivables management services takes off the stress of managing finances and they are free to focus on core business operations. They have also reported a marked increase in working capital, a direct consequence of effective AR and AP management.