I get involved with some aspects of finance at work.I hear people talk about payment terms and cash flow all the time. I thought I would write a real quick, easy to understand article on what this means in basic terms. I’ll tell you how pay terms can increase business cash flow. Increased cash flow is a good thing.
Businesses pay other businesses for their products and services. These products and services are necessary to keep the business running strong. Pay terms are agreed upon and then the transaction happens.
Pay terms stipulate how soon a business is to pay for the product you received. Think of pay terms in relation to how you do business with other people in your personal life. Say you have a buddy, Joe, who wants to buy your car. If Joe says, “Hey, I’ll buy the car for the $1000 you ask but I’d like to pay you a month from now, say 30 days, because I need to pay the rent this week and feed my kids so they don’t starve do death.” he is suggesting 30 day pay terms. If you trust Joe like he’s your best bro ever, you’ll likely extend that 30 pay terms to him . If you don’t believe he’ll actually pay you, you might suggest he pays in 10 days or 10 day pay terms or tomorrow, 1 day terms or before you deliver the car, cash in advance (or CIA) or when he picks up the car, cash on demand (COD)
Cash flow is basically how much loot a business has lying around, liquid, available to spend now. In the above example, Joe is trying to improve his cash flow by delaying paying for the car. If you accept his 30 day proposal, he’ll be able to drive the car, afford the rent, and get some fat on the gaunt bodies of his children. If you, only allow him 10 day terms, he’ll likely be able to feed his kids (at least for two weeks), be able to drive the car, and possibly miss the rent.
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The sooner you get the cash, the more you improve your own cash flow. Once you get the $1000 from Joe, you will be able to use that money to pay your own bills to and keep your home running more smoothly. Without the $1000 you need to make the determination of how long you can go without it. The second you have that money your cash flow has improved (and Joe’s has weakened)
Pay terms also help mitigate risk depending on who is getting the better terms. If Joe doesn’t pay for the car upfront, drives it around for a while, then smashes the car all up, this will weaken your position of getting your money upfront (read: what to do if you crash your automobile) since he’s paid nothing yet. Same goes for it he finds a problem with the car. The opposite is true if you get the money sooner rather than later. Once you have the cash you are in a better position to negotiate any issues with the car.
OK, I Get The “Joe” Example But How Does This Apply To Business? Click Here For The Next Part of this Topic
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