By John Case
A lot of business owners and managers suffer from might be called call financial myopia. They pay close attention to their company’s income statement—they “manage the P&L.” But they don’t devote equal attention to the balance sheet. As a result, they often miss opportunities to free up additional cash.
Here’s a simple example. Let’s imagine your annual sales are $8 million and your average monthly accounts receivable (A/R) for the last 12 months stood at $1 million. Your days sales outstanding (DSO, sometimes called receivable days) is just that $1 million divided by sales per day, or about $22,220. The calculation works out to DSO = 45.
Now suppose you can lower your A/R to $750,000, a 25% reduction, while keeping sales where they are. DSO is now 33.75. You have effectively reduced your working capital needs by more than 11 days’ worth of sales, or nearly $250,000. That much extra cash will show up in your bank account—yet you have neither increased sales nor reduced costs. All you have done is manage the balance sheet.
Is a 25% reduction in A/R realistic? Depends on your situation, of course. But a company practicing open-book management has an advantage: plenty of eyes on the financials. If cash is a priority, sales reps can often negotiate speedier payment terms. Operations folk can ensure that the products and services are of high quality. (Unhappy customers are likely to take their own sweet time in paying their bills.) Customer-service reps can identify other issues that might keep customers from paying in a timely fashion.
You can find more tips like this one in Karen Berman and Joe Knight’s book Financial Intelligence, which has just appeared in a newly revised and expanded version. (Disclosure: I helped Karen and Joe with the prose.) We’ll be presenting useful snippets from this and other sources every month on this site. It’s great when companies practice open-book management, but it’s even greater when everybody in the company knows how to work the numbers for the best possible results.