“Hahahahahaha — wipe out!” *incredible air guitar and drum solo*
Wipe Out by The Surfaris is a regular play for the pool guys and gals at Summertime Splash, a pool maintenance company for home and commercial pools. They can’t get enough of the song’s high-energy drums and catchy guitar riffs while they are fixing leaks, replacing liners, and balancing chemicals. Between May and September, the staff strums along and works on their tan as the cash flow shines down on them as strong and consistently as the golden sun’s beautiful rays.
And then October rolls around… and the clouds slow the warm rays of consistent cash flow from shining, and the seasonal employees say goodbye to Summertime Splash until next year. In fact, cash flow slows down so much in the winter months that the trickle is barely enough to cover payroll for the year-round employees. The comical laughter from the Wipe out song now seems sinister and cruel….WIPE OUT!
This past winter, Summertime Splash decided to cut expenses to save money, so taking advantage of early payment discounts from their vendors seemed like a no-brainer. They would receive a 2% discount if they pay within 10 days of invoice receipt. 2% — that’s a big deal when the cash is at a trickle. Thankfully, they ran the idea by their Fractional CFO before executing their plan, because it was a terrible idea that would have tightened their cash flow even more — and potentially put their business out of business.
Even a small decision like paying an invoice early can wreak havoc on your business’ financial health when cash is tight. Don’t let your business wipe out needlessly. I’d love to be your financial pool gal, helping you balance your financial pH levels, detecting money leaks, and implementing new financial maintenance protocols that will keep your business basking in the financial sunshine all year long. Schedule a meeting with me today.
What is an early payment discount for businesses?
Sometimes, when companies want to improve their cash flow, they offer discounts if their customers pay right away. You’ll see this early payment discount listed on the invoice as a code, such as “2/10, net 30,” which means you will receive a 2% discount if you pay within 10 days; the entire invoice is due within 30 days if you are not taking the discounted price.
You will likely have to calculate the 2% amount yourself, as the total listed on the invoice is the full amount. Check your accounting software to see if there is a place to track it.
Pro tip: Don’t be confused – QuickBooks labels vendor invoices as “bills,” and customer invoices as “invoices.” For QuickBooks Online, the screenshot below shows options to track this discount when adding invoices and bills.
When you receive an invoice from a vendor, you will find their payment terms clearly listed. This is how long you have to pay them for their goods or services before it’s considered overdue. Most vendors generally offer 30-day payment terms. If the vendor is a regular supplier, they may offer 60-90 day payment terms. Anything over this amount of time can stretch smaller businesses pretty thin — you can negotiate vendor contracts to help cash flow.
(Psst…what are the payment terms for your customers? Read all about the importance of a customer payment policy and make sure you have one!)
When is it OK for my business to take advantage of an early payment discount?
If your business is in a financially healthy position and you’ve got a cash runway that can handle some flexibility in cash reduction, taking advantage of an early payment discount is a great idea. It reduces expenses, which increases profit. If you save 2%, it’s the same thing as earning 2% income on the invoice amount.
Here are the critical steps to ensuring it’s OK for your business to take advantage of early payment discounts:
- Calculate the hit to your cash flow (including payroll) and ensure you can absorb it. Your Fractional CFO can help calculate this — and let you know if your cash runway can handle it. Schedule a free call with me today to learn more about this process.
- Choose when you are going to pay early (and when you aren’t). You don’t have to pay early on every invoice. Perhaps you pay early with some vendors and not for others, or some months but not every month. If you know there are certain months when you don’t have the cash flow buffer, don’t do it.
- Track savings from early payments to see if it’s worth the hit to your cash flow. Using a separate account in your chart of accounts makes this easy. Ensure it is “below the line” in your books and listed as other income (not with sales revenue but below operating net income).
- Decide what to do with your savings. What could you do with the extra 2% you receive from paying early? Perhaps spending more on marketing for a season would be worth the investment, or putting the money into a CD. What rate of return (ROI) could you earn if you invested that extra cash back into your business? You could also eventually take it as an Owner’s Draw and use it for a personal project (presuming your cash flow is good when you take it out!). Or maybe spending the savings on a Fractional CFO like me who would bring business growth you haven’t even considered!
When should my business NOT take advantage of an early payment discount?
You should not take advantage of an early payment discount if your cash flow cannot handle the drain to your cash reserve. If your cash runway is short, you need to hoard your money; keep your cash in the bank as long as possible.
If your cash flow is tight, there are many great tools for effective cash flow management that can improve your situation. But paying early is not one of them. Nor should you pay invoices annually to receive a discount: dividing payments into monthly installments is a great way to lessen your cash flow burden — even if it means paying a little more overall.
If cash is tight, talk with your vendors to gain clarity on their payment terms. Here are two quick things to check:
- If you aren’t sure if you can pay within 10 days, but might be able to swing 15, ask how strict they are on their due dates to get the discount. You don’t want to pay early and not gain the discount…that’s a double financial wipe out you want to avoid.
- If they honor a credit card payment with the discount (which is great but unusual), that can also be a way to take advantage of the payment discount while extending your cash runway (because it pushes out the actual withdrawal from your bank account by a month). However, if they add a credit card processing fee, the cost may not be worth the payment discount. There can also be fees when sending wires and ACH payments. In other words, don’t let your savings get eaten up with fees!
Pro tip: Don’t forget to communicate with your bookkeeper! You both need to be on the same page regarding payment timings and processes. This is critically important if you change your mind based on your current situation, or if the game plan changes from month to month. If your bookkeeper is following good internal controls, they may miss the memo that you’d like to adjust.
Bonus Pro tip: If cash is tight, consider offering early payment discounts to your customers to get cash in the door sooner. Yes, you will give up a little profit, but the benefit of more cash now may just save your business from wiping out. You can set up a policy for this to help manage your bottom line. For example, only offer this discount for customer invoices under $5,000.
Find your Perfect Cash Flow pH Balance
Don’t fall for the trap of early payment discounts if your cash flow can’t handle it. I’d love to help you balance your financial pH so that you are confident in your cash runway and are free to enjoy the sunshine of business success while swimming in the crystal clear waters of a financially healthy swimming pool. Schedule a meeting with me today to learn more about my process.
