I was chatting with a business owner recently who pays his company’s creditors (people who they buy things from) only when they have spare cash. There are good months and terrible months, so he reasoned it only makes sense to pay everyone until a good month rolls around.
It was his belief that there was nothing that could be done around it, and that things always come around. He also argued that by paying suppliers early when he could afford to, they appreciated it and were therefore more forgiving when bad months roll around.
At a level, he was right – if you don’t have the cash, you can’t pay your creditors. What he hadn’t realised is that all it takes is a better routine to smooth out cashflow.
I always advocate for not paying your suppliers early, and not paying them late.
Let’s say that in some months, you pay your creditors at the end of the month (when cash is tight, and others towards the beginning of the month (when things are good). So, some months you pay on the 30th, and others on the 10th.
This means that there can potentially be 10 days between paying creditors, if you’re paying on the 30th and then again on the 10th. In this scenario, more often than not you’ll struggle to pay the next round of invoices again on the 10th – you’ll be clean out of cash, and end up paying your creditor on the 30th of the following month. Things will probably be tight again the month after that, and payment will again be on the 30th. After this point, the business will likely have some cash again, and the pressure the business was once under will be forgotten. The next payment will again be paid on the 10th.
So, to recap: this business has paid their creditors on the 30th, then the 10th, then twice on the 30th, and then back to the 10th…
Why do people do it to themselves? Because they think it’s the best way. Just pay on a fixed day each month (the 20th, say), and smooth out your cashflow.
I can hear you asking already – if I’ve got the cash in my account, why not just pay it out? Surely it all evens out?
No, no it doesn’t. Here’s why:
- You will fall into the 30th, 10th, 30th, 30th, 10th trap.
- You will have a large bill from a supplier to match a bumper sales month, and if you’ve paid your other suppliers early, then you’ll struggle to pay the large bill.
- You can’t forecast your cashflow when you fall into the trap (I’ll cover why cashflow forecasting is important on a later day).
- If you pay your suppliers when it suits during the exceptional months, you’ll take more cash for yourself. Now this isn’t a bad thing in the slightest – it just needs to be thought about. Do you take the cash, or do you reinvest in your business? Also if you take the cash today, how easily will you be able to pay your creditors next time around?
Picture it like this: