Continuing from the business series, this post is my notes on money matters in business.
It is easy to get confused about finance or accounting. Many people gets scared when they hear about it. Balance sheet, ROCE, ROI, IRR, NPV, DCF, WACC, CAGR, etc. etc. But when it comes to money in business, there is one principle that takes precedence above the rest.
1. The principle is this: You must collect your money.
Many businesses go bust because they fail to collect their debts. This is a major chronic situation, especially so in desperation to get sales. The best type of businesses are those that collect cash upfront before delivery of goods or services. Heck, the best are those who collect upfront before production starts.
In the course of business, it is easy to forget this principle because the sales numbers are so tempting. And the apparent “friendliness” of your customers makes you believe that they will pay you on the dot. Most of the time, they don’t.
It has to be clear in your mind this thought: bad debts are worse than no sales.
Imagine that you earn 10% profits on your sales. If you fail to collect on just one job, you will have to do 10 more jobs of equal size and margin just to cover the debt that you failed to collect. This is a disaster!
2. The next principle is that you must pay your staff and suppliers on time. And if you have salespersons that earns commissions, you must also pay them on the dot.
Paying people on time establishes trust. Paying salespersons’ commission on time establishes motivation. And these are the people that supports the business, your suppliers and staff. Understand that without their support, for example, if suppliers stop delivering to you on time because you do not pay on time, or they do not deliver high quality raw materials to you, your end products will also reflect such inferior quality. Also, if you do not pay your staff on time, they will sooner or later look for other jobs and those who remain either is your secret admirer hoping one day to be able to marry you or those who cannot find a job elsewhere, which means you are keeping people that nobody else wants.
3. The third principle on money in business is to think of Inventory (stocks) as the devil that needs to be cast away. Inventory eats you dry. You should target zero inventory. Having inventory as “assets” is an accounting laughingstock because inventory is cost.
The problem with inventory is that you expect you can realize them in the future, turning them into cash. The sad truth is that a lot of inventory goes to scrap, and the cash spent to stock them also goes down the drain. This is not a smart thing to do.
Actually, all the above is what we call working capital management, or the cash cycle. It is how fast you get back the cash that you invested into the business and turn a profit. The shorter the time, the better off you are.
For example, imagine if you are selling handphones. The best scenario is your customers pay you upfront the full price of the handphone and then you use that money to buy the handphone from your supplier and then pass the handphone to your customer, keeping the profits in your pocket.
The worst scenario is you stock up one thousand phones hoping that you will sell all of them.
Collecting all the cash upfront is usually not possible nor realistic but you must at least get a deposit. This is a must.
There may be customers that you need to give some credit but still, you need to get some deposits or downpayment. The reason is very simple. If they are genuine customers, why is it that they cannot pay something upfront, as earnest money? And having a deposit will reduce the chances of them canceling the order after you have bought the raw materials/stocks.
If there is one person that is your friend in your finance department, that person is the credit control manager. Have him or her report to you directly. Have standard operating procedures and credit risk management policies in place. Make them inviolable. Stick to your guns, always remembering that one bad debt will take many good sales to recover, so don’t be greedy.
Bad things happen to greedy people.