If you supply products or services to other businesses, you may find that your clients seem to be deliberately prolonging paying your invoices to help control their own cash flow.
However, even when this expected income hasn’t come in on time, you still have operating costs to meet in your business.
Managing the impact of late payments on your ability to meet your business overheads is essential to protect the health of your finances and make your business viable over the long-term.
What are business overheads?
Expenses incurred to run your business that are not directly related to a specific product or service are called business overheads. Some examples of these overheads include staff wages, rental costs, insurance premiums and utilities. Business overheads are referred to as fixed costs as the cost remains relatively constant, regardless of the fluctuations in sales volumes. It’s useful to understand how much these fixed costs total on a weekly, monthly and annual basis. It’s also good to understand that reducing your overheads without compromising your operations, can result in a more profitable business.
Steps to managing overheads
1. Review all expenses
Review every invoice before payment and ask whether you really need to keep incurring the expense. Some items you may be able to dispense with include subscriptions, memberships, cloud storage beyond actual requirements, supplementary insurances that are no longer relevant and so on. Before continuing to pay, confirm whether the continued expense is still required, as circumstances do change. If you no longer need the good or service being supplied, make the necessary arrangements to stop payment and communicate this decision to the supplier.
Do this review as a regular practice for ongoing cost management in your business.
2. Compare costs
If the expense is justified, shop around for alternative suppliers and assess whether you can obtain better value for money. It’s easy to get caught by the ‘lazy tax’ —the phenomenon of being complacent about checking alternatives or negotiating for a better deal from your long term supplier and therefore paying a higher price than you need to.
Consider approaching your current supplier with evidence of comparative quotes, to see if they can improve their offer. Whether you change or retain your current supplier, explore options for extended terms of payment and discounts where applicable.
3. Recalculate minimum revenue
Now that you have reassessed your costs, review the total overheads your business needs to meet on a monthly basis and the minimum revenue required. If the delayed payments from debtors will continue to cause financial stress after your aggressive cost reduction campaign, continue with steps 4 to 7.
4. Start supplier negotiation
Negotiate with your suppliers about whether extended terms can be offered until your finances are back on track. In some cases, they may be willing to grant softer conditions, such as delayed payments, if approached the right way. This can reduce your monthly overheads while you are experiencing a reduction in available cash.
5. Overhaul your terms
Review your own terms and conditions or terms of trade. Do they need to be tightened further to shorten the cash cycle and collect sales revenues more quickly? Don’t forget to have a lawyer review these to make sure they are watertight.
6. Check your profit margins
Review the gross profit margins on your sales mix to evaluate whether it’s time to increase prices and improve your margins. Your gross profit is your revenue, minus the cost of goods sold (COGS) and is an indicator of efficiency. The higher the gross profit margin, the better, as your business keeps more from each dollar of sales.
7. Remove or control bad debtors
Prepare a ‘black list’ of debtors who have overdue invoices. Place a hold on delivering further orders until the backlog of delayed payments from them is recovered. If certain customers have a history of not paying, or there are warning signs that they are experiencing financial difficulties, put them onto a cash on delivery basis. You or your staff should follow up regularly when payments are late. Be careful too about extending credit — it is useful to buy a credit history report to assess your customer’s likelihood of falling into financial difficulty.
More information
By following these steps you will have completed a health check of your overheads and have improved your internal cost efficiency. Even when you are struggling with late payments from your debtors, this process will increase your eventual cash position and ultimately your profits. For more helpful resources to manage your finances see:
