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Prioritizing Accounts Payable

David Chavez, CEO, Chavez and Koch, CPA's, LLP

As in any business, cash gets tight at times. So an effective method of managing your company’s cash flow is using accounts payable. Cash is the life blood of business. If you do not have cash, vendors will not supply the goods and services your business needs to survive. In our CPA firm, we consider our vendors a critical part of our team, and I think most successful entrepreneurs do as well.

The first thing to know about accounts payable is that you can negotiate your accounts payable in advance. This may seem obvious to some of you, but many entrepreneurs believe that the vendors have their terms and their terms are their terms and that is final; not true. Many small or mid-sized companies will bend their standard operating procedures for good customers or a new customer that communicates with them at the time pricing is worked out.

For example, one of our clients is a chemical supply company. When starting his business I advised him to set all of his contracts up with ninety day terms, which he did. On his own, after learning he could negotiate the terms, he also negotiated his initial order with 120 day terms – leaving him with over $200,000 in free cash flow for six months. He used this money to hire sales people, increasing his sales beyond his original projection.

When you have a relationship with your vendor, it is important for you to be a great customer. Constantly complaining to your vendor about issues that are not important or treating them with a lack of respect can cause you problems when cash is tight. Even if you are their best paying customer, but you nag or treat them with a lack of respect, you are not an “A” customer. Some customers are just not worth having no matter how much they are paying.

I received a referral from a client and upon visiting the potential client’s business we started evaluating his liabilities to determine how we were going to improve this company’s cash position. When the controller told me that the owner yells at most of the vendors, I was not surprised when none of them were willing to extend any more terms to the company. Always be respectful even if they are not a good vendor.

Once vendor terms are negotiated, you are treating your vendor as a critical part of the success of your company. So when you start experiencing cash flow problems, what do you do? Start by making a list of your vendors, giving each of them a grade based on their importance to pay. The main thing to determine is how to use your cash in the best manner while trying to keep everyone happy.

Determine those vendors to whom you have personal credit attached; these are your “A” list vendors that will be paid on time. Most of these vendors are large vendors like American Express or your office supply company. If you do not pay them on time, the decision will affect your personal credit right away.

Then determine the vendors that are reporting to agencies such as Dun & Bradstreet (D&B) about your business credit; this is your “B” list. Usually the “B” list also includes large companies like your main supplier (if they are a good-sized company) or your telephone company.

Next are the vendors that can have an impact on your credit but are not likely to take action until they notify you. You want to split these vendors into two groups–one group includes vendors critical to your success (the “C” list), and other vendors are easy to replace (the “D” list).

Now the vendors are classified A through D. The classifications along with available cash flow are used to make payment decisions:

  • The “A” list is always paid on time.
  • The “B” list is paid as quickly as they can be, usually paying half on time and the other half just before they report to D&B (usually no more than thirty days from the invoice due date).
  • The “C” list is paid as quickly as possible (communicate with the vendor when payments are delayed).
  • With the “D” list you wait until they initially contact you about your late account before starting to pay or even communicating your poor cash flow situation to them. There are many companies out there that do not manage their collections correctly and you can use that to your advantage.

Say a vendor from group “D” calls and your cash flow is minimal. Send them a partial payment to get off their immediate radar screen. Paying as little as ten percent on an invoice might buy you another thirty days.

Here’s the bottom line: with all vendors, your critical task is to communicate with them. Do not stick your head in the sand and act like you do not owe vendors money–you are asking for trouble. Pick up the phone and tell the vendor you are having cash flow challenges and you need extended terms. Most vendors will never send a customer to collections that is communicating with them and making some attempt to pay.

© 2006 David Chavez. All rights reserved.

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