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Thread: Acceptable cash to credit ratio?

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    Acceptable cash to credit ratio?

    Hi guys.

    What would you say is an acceptable ratio of cash vs account customers in your business?

    We have quite a few car dealerships doing business with us, as well as some security and other transportation businesses.

    Currently, our cash turnover makes up 42% of our business. To me this doesn't sound like a healthy mix. This means (in most basic terms) that 58% of my turnover is at 'risk' Obviously this is a slight exaggeration as not all account holders are bad payers...

    This also translates to serious stress for a book keeper as it means at month end, you know which creditors need to get paid how much and you (in effect) only have 42% covered

    Please share your experience with me?

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    This is an interesting question, and is largely dependent on the industry you are in.
    First comment: If your business is not obtaining revenue from extending credit (more interest on the outstanding account than what you are getting from the bank), then you are indeed loosing by giving terms.
    Second comment: If you are paying your creditors faster than what your debtors are paying you, not so good.
    Now for the consideration questions:
    If you were to go 100% cash, what % of your customers (sales) would you loose, who are they, and what will be the impact on your business if you loose them?
    If the above is a problem for you, are you charging a premium on such accounts (ok, are you offering a cash discount on your cash accounts) to entice them to pay upfront?
    What does your competitors do and how well / or not is it working for them. e.g. Foshini Group has around 42% cash sales - similar to you - whereas Mr Price does not extend credit (they did, but stopped it). Have a look at their financials to see who is performing best (profit %).

    Hope this helps - as I am not sure which business you are in, and simply assume it is not microlending, my overall advise is - improve your cash turnover and get rid of the credit customers.

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    I am in the tyre industry.

    Short answer: No we are not obtaining revenue from extending credit. In fact, because we have to do with dealership (some spending up to R70k with me) their prices have to be better than cash, especially in this cut-throat environment. Basically it becomes wholesale.

    Losing the credit customers means losing 58% of my turnover. That would mean closing doors.

    This is the thing for me: Our monthly turnover swings between R800k and R1m a month, but the debtors book seems to stay on about R700k-R900k. Obviously fluctuates as debtors pay accounts at different times and keeps buying. We declare a net profit of about R500k a year. But the directors never sees a dime. We get our salaries, but the profit is tied up in the debtors book....and of course now we have to pay income tax on money that hasn't come in...

    I am advertising in local media and social media trying to boost cash sales, but I have yet to see results. Even giving away half a lamb at month end...

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    In my opinion, this ratio is not an important one to consider. Rather consider the Accounts Receivable Turnover Ratio and the Customer Days Ratio.

    Accounts Receivable Turnover = Net credit Sales / Average Accounts Receivable
    The higher this is the better, meaning more cash from credit sales

    Customer Days Ratio = Accounts Receivable x 30 x period / Sales (Year to date figure)
    How many days the customers pay. Again an important consideration for your cash flow. The lower the days are the better as this means you are getting your money faster.

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    The Accounts receivable turnover ratio, I don't think will be effective. Reason being, some debtors pay on the 25th, whereby others are still outstanding, some pay on the last day of the month, whereby the debtor that paid on the 25th started buying again, and some are still outstanding and some pay on the 7th, whereby for the customer that paid on the 25th already have half a month of buying behind him. Maybe I'm wrong, not a financial buff, but neither are my partners.

    Customer days: Most pay 30 days (big accounts, R30k to R70k), one pay 45 days (very big, about a R100k), very few customers over 90 days, but they are small accounts (R6000) then we have a couple of guys who are struggling to pay, so we are getting R500 a month on a R4500 account.

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    Have you thought about offering a settlement discount for accounts paid before 30/60/90 days or discount for cash payments?

    The other way of freeing up cashflow would be to factor your books with the bank.We use factoring and it has helped us grow our business.You would have to do the sums and see if it could work for your business.
    Last edited by roryf; 20-Feb-15 at 10:50 AM. Reason: Additional info

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    Quote Originally Posted by roryf View Post
    Have you thought about offering a settlement discount for accounts paid before 30/60/90 days or discount for cash payments?

    The other way of freeing up cashflow would be to factor your books with the bank.We use factoring and it has helped us grow our business.You would have to do the sums and see if it could work for your business.
    Factor our books? What does that mean? Sorry, my friend Google is leaving me in the lurch...

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    Quote Originally Posted by Hannes Botha View Post
    The Accounts receivable turnover ratio, I don't think will be effective. Reason being, some debtors pay on the 25th, whereby others are still outstanding, some pay on the last day of the month, whereby the debtor that paid on the 25th started buying again, and some are still outstanding and some pay on the 7th, whereby for the customer that paid on the 25th already have half a month of buying behind him. Maybe I'm wrong, not a financial buff, but neither are my partners.

    Customer days: Most pay 30 days (big accounts, R30k to R70k), one pay 45 days (very big, about a R100k), very few customers over 90 days, but they are small accounts (R6000) then we have a couple of guys who are struggling to pay, so we are getting R500 a month on a R4500 account.

    I think you should still try it...

    Definition of "Receivables Turnover Ratio"

    By maintaining accounts receivable, firms are indirectly extending interest-free loans to their clients. A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient.

    A low ratio implies the company should re-assess its credit policies in order to ensure the timely collection of imparted credit that is not earning interest for the firm. - I think this is exactly what you're trying to find out?

    To better manage the debtors offer them discount for paying earlier, the moment a big company gets discount they will pay earlier

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    Factoring or invoice discounting is when you sell your companies invoice book to the bank or similar establishment.They then give you a percentage of the invoice value,say 80% within a short time period (1 or 2 days) and the 20% balance is paid to you once your customer pays the bank in full.The factoring will have some sort of interest charge and commitment charge to make it worthwhile for the bank.

    Factoring works for some.It has helped us grow our business fairly quickly.

    http://en.wikipedia.org/wiki/Invoice_discounting

    Ideally you would want cash payments as they are always the best...

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    Quote Originally Posted by roryf View Post
    Factoring or invoice discounting is when you sell your companies invoice book to the bank or similar establishment.They then give you a percentage of the invoice value,say 80% within a short time period (1 or 2 days) and the 20% balance is paid to you once your customer pays the bank in full.The factoring will have some sort of interest charge and commitment charge to make it worthwhile for the bank.

    Factoring works for some.It has helped us grow our business fairly quickly.

    http://en.wikipedia.org/wiki/Invoice_discounting

    Ideally you would want cash payments as they are always the best...
    Does the bank then take care of collecting the monies for their "fee" which I suppose gets deducted from the 20%. Which companies in SA does factoring?

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