Just like managing your debtors, management of creditors is vital to your business' cash flow. Your objective should be to maximise the length of time between the purchasing of goods or services and playing for them without damaging the business’ reputation with its suppliers. If you don’t manage your debtors, you’ll be put in the unfortunate situation of not having sufficient cash to pay trade creditors.
Problems with your creditors
The following are all indicators that your business may not be considered a “good risk” by your creditors.
- Creditors are no longer willing to satisfy further orders until outstanding invoices have been settled.
- The business’ overdraft facility has exceeded or been fully utilised.
- Financing costs have increased.
Causes of the problem
- Inventory levels have increased to an unacceptable level. This ties up too much of the business’ cash in inventory.
- Debts owed to the business have increased to an unacceptably high level – this takes cash out of the working capital cycle.
- There’s lack of control and direction over the inventory ordering policy.
- Different payment periods haven’t been utilised to their greatest effect.
- There’s lack of negotiation with creditors to establish agreeable payment terms.
Short-term solutions
- Try to renegotiate payment periods with creditors.
- Pressure debtors into paying more promptly, e.g. impose penalties for late payments.
- Find out whether there are other suppliers who will be willing to provide the inventory on more reasonable terms.
- Try and extend the business’ overdraft facility. (If necessary, consult other financial institutions.)
- Consider each creditor’s individually and pay invoices at the latest time each creditor will accept.
- Calculate the average time allowed by suppliers/creditors to pay and ensure that your business terms allow the same period or shorter with debtors.
Long-term solutions
- Verify if the inventory ordering policy is working effectively.
- Ensure that all payment periods are fully utilised.
- If sales are seasonal and production scheduling is constant, make sure that there’s enough cash left in reserve for the low sale periods. Prepare a cash budget for all cash expenditure and, if a shortfall is forecasted, pre-arrange finance.
- Ensure all payments are authorised by you or an authorised employee prior to settlement of the debt.
So a supplier gives you a bad time or bad service and you think you’ll get them back by refusing to pay or delaying payment for an extended time? Be careful – you may end up adversely affecting your credit rating, which can leave you worse off as a result.
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