March 2007 NEWSLETTER: 5 Minutes to Improve ...
"5 Minutes to Improve ..."
This newsletter is a free service to the North American not-for-profit community from William Harper Associates. Its focus is on helping organizations that do good, do better ... by identifying practical ways that small- to mid-sized organizations can improve their operations, one small step at a time, in just a few minutes.
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March 2007: 5 Minutes to Improve ... Your Cash Management
This month's '5 Minutes to Improve ...' idea is to improve how you pay your accounts payable.
With interest rates having been at reasonably low levels for some time, many not-for-profits don't focus quite so much on the timing of paying amounts owing to others as they used to. But, low interest rates in our economy can be deceptive, since they don't reflect the rates generally inherent in early or late paying amounts to others. The bottom line: paying your invoices too early or too late is a problem.
Early payments - sure, paying your invoices as soon as they land on your desk can help keep life simple. And, as described below, there are lots of good reasons not to let those invoices slip for too long. But, paying them too early can be costly for a couple of reasons:
1. You lose the use of your cash sooner. Obviously, you will have to pay these bills sooner or later. But, why give up your hard earned cash any sooner than you have to? Better that you keep that cash, and earn at least a bit of interest on it. (The cash would be sitting in a chequing account earning no interest anyway, you say? Well, that's a problem in itself … one for another day!) It may be more than interest on those amounts that's at stake, however. Your bank may give you benefits for maintaining a minimum balance, such a waiving service charges, or giving you a higher interest rate on the full balance. Paying even a small invoice might move you below a threshold that ends up costing you a lot. Or, in the extreme, it may trigger moving funds over from a savings account, or even cashing investments earlier than necessary. In an extreme situation, this simple act of paying an invoice early could be very costly, so why do it?
2. You lose the opportunity to review invoices. Paying invoices before they are approved by the right people or reviewed by appropriate staff can result in amounts being paid that shouldn't be. And, it's much tougher resolving amounts in dispute, or negotiating lower amounts after the full amount has been paid. Finally, once invoices have been paid, they often get filed away and perhaps never reviewed or approved.
Late payments - as discussed above, it's a good idea to leave accounts payable until the right date. But, if you pay invoices after their due date, several bad things can happen:
1. Your credit rating can suffer. Many organizations will make reports to credit bureaus about the credit worthiness of their customers. And, while you may think that eventually paying all amounts owing will leave your credit rating intact, it just isn't so. Chronic late payers are loathed by many organizations, and one (or worse, more) indications of such in credit reports can spell bad news. If your organization ever has to borrow money (even a normal operating line of credit, or a mortgage on a building, for example), you will pay more. And, even just arranging credit with a new supplier can be difficult.
2. You will have more work. Unpaid bills are a headache for companies, because they have to follow up on outstanding amounts. That translates into more work for you, too. Answering calls, reviewing unpaid notices and statements, and arranging for rush payments all take up your valuable time.
3. You'll likely incur obscenely high interest charges. Late payment penalties and interest are surprisingly expensive. First off, the rates are never favourable - they are meant to be punitive! And, second, the charges are often calculated back to the original date that purchases were made. The net result of these two factors is that you could be paying effective interest rates of double, triple or even more digits for the few days that you are late in paying.
So, when is the right date to pay invoices? The due date is a good place to start, but it's only a start. It's important to look carefully for any discounts or other benefits from paying at an earlier date. Some invoices will show a discount, such as 2/10, which means a 2% discount if paid within 10 days. And, when you figure that out as an annual interest rate compared to paying the balance in a typical 20 days (over 70%, completely free of risk), it's likely the best investment you'll be able to make all year. Some vendors may offer other benefits that are worth considering, such as premiums or points of some description.
Not all invoices offer this kind of benefit, of course, but any that do offer an unbeatable deal. The effect of taking every such discount over the course of a year can be very gratifying!
How to do it in 5 minutes. OK, you're sold on managing your payments a little better, but how? Isn't this going to be a lot a work or headaches? The answer is simple.
For smaller organizations, just buy a file folder with the days of the month (1 through 31) marked on its sections. As you look at each invoice, figure out the right date to pay it (the due date, or earlier discount-related date), and file it in the appropriate section. Then, each day, you simply pay any invoices that are in the section for that day. If you know you won't be in the office tomorrow, pay those invoices too. And, if you only want to pay invoices periodically (once a week, for example), then file the invoices on the day that you want to do this task, immediately before the right payment date. So, if you need to pay an invoice on Wednesday the 25th to take advantage of a discount, but you only want to pay invoices on Mondays, file the invoice under 23. The two extra days is a small price to pay for simplifying your life and taking advantage of a great discount.
For larger organizations, talk to your bookkeeper about the best way to do this. Many accounting systems offer a facility for automating this task, by entering the invoice into the accounting system right away, and allowing it to schedule the payment at the best time and automatically produce the cheque.
A word of caution, however. Whatever process you put in place, don't forget to provide sufficient time for invoice approvals and cheque signing (especially if you are relying on volunteers who may only come into your office infrequently). In fact, the volunteer portion of steps can happen without delay, and signed cheques then held if need be (under lock and key, by the way!) until the payment date. Also, remember to allow time for mailing of cheques or online bank-to-bank transfers, particularly if experience tells you that some vendors are sticklers for actually receiving payments by particular dates.
The key here is to be aware of the costs and benefits associated with paying your invoices, while implementing a simple, practical system that works in your circumstances. It's not about designing a perfect system that is a nuisance to you; it's about designing a good system that gets the job done with a minimum of hassles.
William Harper Associates has broad experience in developing, implementing and managing practical and effective operational processes. If you could benefit from improved financial management, please contact us - we can help!