The Effect on Cash Flow of Slowing Payments on Accounts PayablePosted on July 8th, 2017
Outsourced Accounting Department, Inc.
In my previous article, “The Effect on Cash Flow of Improving Receivables Collections,” I referenced an article from Entrepreneur Magazine, “How to Better Manage Your Cash Flow,” in which the author explains, “At its simplest, cash flow management means delaying outlays of cash as long as possible, while encouraging anyone who owes you money to pay it as rapidly as possible.” I then illustrated how reducing accounts receivable turnover from 45 to 30 days reduced the company’s dependence on its line of credit, and eventually started to accumulate cash in its bank account.
In this article, I will now illustrate the effect of changes in accounts payable turnover on cash flow. Again, I’m using an alternative method of looking at “cash flow,” that is in terms of the company’s borrowing availability against accounts receivable and inventory.
To illustrate, first view the below projected cash flow with accounts payable turnover assumed to be 45 days. Note the heavy dependence on the company’s line of credit to maintain this:
Now look at what happens to cash flow if the company slows its payments on accounts payable to 90days. Note the reducing dependence on the company’s line of credit through the end of the year until the line is almost paid off:
Obviously, postponing payments on trade debt to 90 days is NOT recommended if you want to keep supplies coming in, unless of course you can persuade your suppliers to grant 90-day terms across-the-board, which is highly unlikely. But, as was pointed out in the above refenced article from Entrepreneur Magazine, in difficult times, your suppliers have more incentive to work with you than do banks.
The above incentive on the part of suppliers proved to be a life-saver for a client I worked with several years ago. Due to unforeseen developments, the company suddenly became “over-advanced” on its asset-based line of credit. Unable to borrow more from the bank to pay down its payables, the only way it could keep supplies coming in was to negotiate extended payments terms with some critical suppliers.