Your cash flow may be severely impacted and you need to correctly forecast it
Have you ever wondered why some of your customers don’t seem to honor the payment terms they have purportedly agreed to? Are their payments always late and almost never match your actual invoices or billings? Do they seem to short pay some of your invoices?
If you primarily sell to distributors and especially to larger, national and regional ones, you probably experience frequent customer account adjustments and reconciliations, and aged receivables that are always beyond anything resembling reasonable terms. Your AR staff may constantly be managing these “past due” invoices, engaging in endless phone calls, arranging for payments on certain invoices, getting explanations on unexpected deductions and short payments and maintaining their own “home grown” receivable schedules outside the accounting system’s AR sub ledger.
This is all very common among the many SMBs (Small and Medium Sized Business) who sell products to larger customers. You may have asked yourself why this was occurring and the reasons for these revenue cycle patterns associated with it. You may have also learned to live with it, accepting it as part of doing business with these customers.
While many larger customers have the ability and clout to dictate very favorable payment terms to their vendors, a lot of these short payments have to do with the way their distribution contracts are structured and agreed to (either reluctantly or not knowingly) by their smaller vendors. These contracts usually include a myriad of deductions triggered by vendor violations, ranging from shipping violations such as incorrect labeling of cartons or use of non-standard shipping containers and pallets, to billing violations and more. The end result are deductions on specific vendor invoices and short payments on outstanding A/R balances.
But the main issue that SMBs face are slow payments from these customers, seemingly far in excess of their established payment terms. Many large companies tend to “internally” increase the time it takes them to receive, approve and process vendor invoices, effectively improving their own cash flow by delaying payments to their vendors. However, the main reason lies again in the distribution agreements (i.e., contracts with their vendors) and certain definitions and stipulations in these agreements.
Some of the common stipulations you’ll invariably find in this type of agreements are unlimited rights of return and payments to vendors no sooner than a certain number of days following the invoice date and for only products that have sold through to their customers, which are usually retailers and certain large end users. Although the word consignment is never mentioned in these agreements, these stipulations establish the seller-buyer agreement as effectively consignment sales.
You may have passed ownership of products to your customers upon shipment, maybe even recognized revenue at the time of shipment but in reality what you have done is only transfer products to your customers’ warehouses. According to US GAAP you still own the goods.
On the bright side, there are many advantages to vendors with distribution agreements, such as availability of products for immediate delivery to the distributor’s customers, many of whom cannot be effectively serviced directly by the vendor, better market exposure by being associated with a well-known distributor, access to distributors’ co-op advertising programs, cross-marketing opportunities and more.
On the finance end of things, once the distribution agreement is in place, you must recognize its characteristics and understand the implications caused by them to your cash flow. This means that you need to incorporate these “consignment sales” into your planning and budgeting in order to completely and accurately forecast your cash flow and revenue recognition and arrive at properly forecasted financial statements. The same goes for forecasting your inventory needs in order to make these sales and their impact on cash requirements.
SMBs using Intelligent Planning technology at the core of their planning, budgeting and analysis solution realize that revenue cycles including such customer distribution agreements, implying consignment arrangements, can actually be modeled in the software.
Not only can you assign specific payment terms to your customers, per revenue line, product line, etc., you can also model any sales that fall under this “consignment” presumption using drivers, recognition methods and other business logic, built right into the software solution. This will result in much more accurate cash flow forecasts since the vast majority of cash entering the business is from customer accounts receivable collections.
Whatever your revenue cycle is and whether or not some or all of your sales can be characterized as “on consignment”, you must get a handle on your cash flow projection and know it well in advance. Fortunately for SMBs, contemporary FP&A solutions are designed to deliver these results year-round and in an environment you will continually want to be in and frequently participate in the process.
Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software. In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.
Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.