Whose Money Is It Anyway?

Tolerate uncollected debts and you might as well be giving your customers no-interest loans. Why would any entrepreneur do that?

By Leonard Green and John Altman

Entrepreneurs seeking money for growth are likely to think in lock-step fashion: venture capital, angel financing, and debt instruments, as well as lines of credit. Yet another source of funding -- one that is just as important -- may be staring them right in the face.

That is the money they are owed after delivering a product or service to their customer and prior to receiving payment. In business parlance, this is an "account receivable," or simply a "receivable." And the process of assuring that money owed makes its way to the company's coffers is called "collection."

Collecting well might be an entrepreneur's best strategy, as it enables the business to quickly turn receivables into cash. After all, whose money is it anyway? The answer is that from the time of delivery of your product or service, the money is really yours. In effect, itt has been "loaned" to your customer for the period of time you have agreed upon: your payment terms.

What follows is a look at how to collect on that loan faster and more efficiently so that you get what is rightfully yours.

The importance of cash flow. As former entrepreneurs -- we have been founders, sole proprietors, partners, or major shareholders of 10 businesses -- and now, professors of entrepreneurship, let us first put on our professors' hats to explain how collecting well boosts one of a company's most vital underpinnings: cash flow.

The lesson is to recognize the importance of cash flow, which refers to the amount of money flowing in and out of an entity at any given time. Significantly, cash flow differs from profitability, which is revenue minus costs. A business can, and must, be profitable if is to survive, but it can be profitable while its cash flow is in the red.

The difference lies, in part, in the timing of the money owed to the business -- its receivables -- and the money it must pay to vendors, staff, and other stakeholders. If invoice value exceeds the amount of costs, the transaction should be profitable. However, if you haven't yet received a check from the buyer of the goods or services, you still have to pay your suppliers in a timely fashion. More than likely you have just entered the perilous terrain referred to as "cash flow negative." Since a cash flow shortfall that persists can sink a business more readily than a lack of profitability, entrepreneurs must manage receivables with an eye toward maintaining a positive cash flow. Negotiating extended payables will also alleviate a potential cash crunch. We never pay suppliers late, unless we call them for permission in advance, or negotiate better terms before purchasing from them.

Build collections into your terms of sale. Next, we are going to put on our entrepreneur's hat. In the course of presiding over several entrepreneurial ventures, one strategy that worked well for us in the early, and even later, stages was to introduce terms at the beginning of a sales presentation, rather than as an afterthought.

At one of John's last companies, a manufacturer of acrylic plastics for the automotive and lighting industries, he would clearly emphasize terms of sale. For example, if he expected to be paid "Net 30" -- that is, within 30 days from time of shipment -- he would state this in the very first paragraph of his sales proposal. In this way he tied pricing structure to being paid on time.

In addition, he emphasized what it was that made his company different from the competition, what merited it seeking and receiving timely payments of invoices. For example, he was able to process customer orders in three days, provide customized packaging, and provide technical service 24/7. As a result of stressing capabilities and the need for prompt payment as a privately owned entrepreneurial company, he found that most customers complied. General Motors even paid within its 30-day terms, though competitors often waited 60 or 90 additional days. The lesson here is that by emphasizing your need as a privately held company for strict adherence to the terms of sale, you will find that many customers will help you out, even at the expense of paying big companies late.

Use collections to motivate your sales force. In order to consistently receive your money on time, you must also integrate the collection of receivables into your methodology for compensating your sales force. In other words, you must delegate responsibility for timely receipt to your sales personnel as a condition of sale.

At the companies John headed, the remuneration package for the sales department included performance awards for prompt payment of invoices. By building a team relationship between your credit and sales departments at the onset, you also will be surprised about how much you can learn about a customer before you assign a line of credit. No one is closer to your customer than the field sales representative.

The lesson here is that good sales people quickly pick up the importance of cash management, especially when their compensation is tied to it. Sales people who use credit as a sales tool are quickly self-disciplined by bonus penalties.

Negotiate better terms with suppliers. With the basics of collecting in order -- that your customers and sales personnel understand and adhere to your requirements -- turn next to the third leg of the receivable stool: your suppliers. The lesson is that there is always room for negotiating better terms. At the most basic level, of course, you should never pay an invoice promptly unless a meaningful discount applies. Instead, wait the full period before writing that check.

In addition, negotiate with your suppliers for longer credit terms and/or increased credit limits, both of which can create free finances to help fund future sales.

Manage the time aspect of collecting. The final lesson is a proverbial one: In collections, as in so many business transactions, time is money. You need to incorporate that philosophy into the DNA of your company. Develop a sense of urgency about all aspects of your business!

Therefore, invoice in a timely manner, specifically the same day your product or service is shipped or delivered. Your customers can readily, and fairly, use the excuse that they are a week or two late in paying if you have invoiced a week or two late! Build in techniques that could help speed payments your way. For example, you should consider offering customers a discount if they pay prior to the due date -- or charging a penalty if they are late. Admittedly, it is difficult to collect late charges. Also consider accepting credit cards and debit cards as payment options.

Once receivables begin to age, be proactive about collecting. A system establishing, reviewing, and monitoring credit limits for each customer must be in order, as well as a means for establishing and dealing with aging reports. In an age of technology, a daily aging report is essential and inexpensive.

The lessons we have learned about collecting, as both professors and entrepreneurs, have served us well in our businesses and saved very substantial amounts of interest on funds that did not need to be borrowed. The money is yours, after all. Make sure you collect it in a timely manner.

John W. Altman joined the Ewing Marion Kauffman Foundation as a Vice President in June 2000, leading a team seeking to advance the Foundation's mission of accelerating entrepreneurship by identifying new opportunities and determining how to maximize current programs. In 1998, Altman became the first Robert E. Weissman Professor of Entrepreneurial Practice at Babson College.

Leonard C. Green is the founder and CEO of four family businesses. These include The Green Group, a New Jersey C.P.A. and entrepreneurial consulting firm; Jobel Management Corporation, a multistate real estate company; DJ Stable, a thoroughbred racing and breeding operation; and Entrepreneurial Strategies Group, a family business consulting firm. Green is an adjunct professor of family business and entrepreneurship at Babson College.

Entrepreneur's Byline comes to BusinessWeek Online readers courtesy of EntreWorld.org, a resource for entrepreneurs that is sponsored by the nonprofit Ewing Marion Kauffman Foundation.

    Before it's here, it's on the Bloomberg Terminal.