‘Slow Pays’ Pose Dilemma For Businesses
The top line of a financial statement reflects the number one priority of every firm - SALES.
Sales produce the cash that keeps the heart of the enterprise pumping. But cash isn’t always collected quickly, since many customers hold off payment for the goods and services they buy for as long as possible.
After all, cash is important to them too. This kind of standoff, of course, can create a cash crunch for the firm awaiting payment.
Q: Too many of my customers typically hold off payment for 60 days or more. They are credit-worthy but always late, and I need the cash to fund my day-to-day operations. I’m afraid to press them since I need their business. Any ideas?
A: The most obvious, effective solution is to invest more cash into your company, expanding its working capital so that “slow pays” don’t crimp your ability to conduct business. But this is easier said than done.
Reducing your need for cash is another alternative. Are you sure you need all the inventory you have, and that all of your expenses are absolutely essential? Reductions here can help you conserve cash.
You might also try to accelerate your collection process a bit, perhaps offering a discount for prompt or early payment.
If you can’t “push” your customers without fear of losing them, you might resort to turning your customers’ IOU’s into immediate cash by using a “factor.”
Factors are firms or individuals who specialize in buying your customers’ indebtedness to you for cash. You get the factor’s money when you need it, and the factor collects when your customer pays.
As you might imagine, this is not a free service, and it is not available to every firm. Your factor will do a credit check on your customers and may not accept all accounts. Those who pass muster will be assigned a credit limit.
The factor then becomes responsible for collections. If these collections are performed “without recourse,” the factor assumes all credit risk. If your factoring contract allows for “recourse,” the factor can require you to make good on the deficiencies of deadbeat customers.
Once you’ve adopted factoring, you will send your factor a copy of every invoice you generate, and the factor will pay you either after each sale or at the end of an agreed upon “collection period.”
Predictably, there is a cost for this service. The commission typically ranges from one to two percent - or more - of the invoices factored. It’s expensive, and the cost may outweigh the advantage if you have a large number receivables with small balances.
On the other hand, the price may be right if your cash-creating options are limited and factoring helps you make better use of scarce working capital.
Q: You recently described the ways in which a 401K plan can help an employee provide financially for his or her retirement. It sounded great, but after checking into it, it seemed kind of elaborate for a firm my size.
I have only four employees and I need something easy and inexpensive to administer. Is there a scaled-down version available?
A: No, but a good alternative is the SARSEP Salary Reduction Simplified Employee Pension Plan. Like a 401K, a SARSEP will allow an employee to squirrel away up to 15 percent (to a maximum of about $9,240 in 1995, based on the change in the cost of living) of their pre-tax compensation in a variety of savings and investment vehicles. Once there, monies can accumulate, tax-deferred, until withdrawn.
A plus for SARSEPs is that they are simple and cheap. Since they are individual employee retirement accounts and not actually qualified retirement plans, they suffer fewer costly, confusing rules and regulations.
Contributions by employers are tax deductible, however, just like those to a 401K plan. Moreover, while a 401K plan may cost up to $1,000 or more a year to administer, in addition to a per annum employee fee in the neighborhood of $10 to $30, a SARSEP can be implemented for a cost of about $300 to $500.
From an employer’s point of view, a SARSEP suffers a few severe restrictions that don’t apply to a 401K. While a 401K permits an employer to require one year of prior service from an employee before he or she can become eligible for participation, SARSEP participants are immediately vested.
Furthermore, part-time employees cannot be excluded from a SARSEP; at least 51 percent of a firm’s eligible employees must contribute during a plan year; and, there may not be more than 25 people employed by the firm at the beginning of the plan year.
I still favor the 401K vehicle, but SARSEPs can be an attractive alternative for the small, cost-conscious firm and for the entrepreneur with limited time to spend on administrative affairs.
xxxx Paul Willax is the Sandifur Distinguished Professor of Entrepreneurship at Eastern Washington University.