FinanceFor Small Business, a Cash-Flow CrisisBy John Tozzi March 24, 2011
Custom cabinet seller M&J Kitchens survived the recession even though its revenue from homeowners and builders fell by more than half in 2009. Then, last August, with sales tracking 42 percent higher than a year earlier, owner Drew Davies shut the East Greenwich (R.I.)company after 26 years, unable to pay his bills. M&J was a casualty of a cash-flow crisisprecipitated by his bank and suppliers that, Davies says, cut off credit lines that had been in placefor decades.
Small businesses face what could be a permanent legacy of the recession: Their vendors are demanding faster payment even as their customers take longer to pay. That means companies with the least clout get squeezed the hardest. “The slow down of currency, of money, the exchange, put us in a very precarious position,” says Davies. “We basically had panic from our vendors.”
The average time private companies took to collect accounts receivable increased to some 27 days in 2010 from about 23 days in the previous four years, according to accounting software maker Sage works, which analyzes private company financial statements. Payment times jumped to an average of about 24 days, up from roughly 20. The largest corporations are even slower: Companies in the Standard & Poor’s 500-stock index paid vendors in 59 days, on average, in the most recent quarter and collected payments in 46 days, according to data compiled by Bloomberg.
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Davies says many of his customers had slowed their payments from 30 days to 60 or 90. At thesame time, the cabinet manufacturers he ordered from cut his credit lines or required deposits,which Davies says tied up $60,000 to $120,000 per month. Although Davies says he was current on his loans, his lender, Citizens Bank (RBS), pulled his credit last March, saying his assets had dropped below the level required by the loan agreement. (The bank declined to comment.)
M&J Kitchens, which once employed 12 people and grossed as much as $4 million a year, wentinto receivership at the end of August. “Without the cash flow we were used to … we didn’t have great negotiating power with the bank,” Davies says. “We were getting squeezed from both sides.
“Late payments can ripple through the supply chain. Wood-Mode, one of the cabinet lines Davies sold, says its customers have slowed their payments, and fewer are taking advantage of discounts for paying in 10 days. Nick Yoder, credit manager of the Kreamer (Pa.) company, says WoodModetries to be flexible with its 1,200 dealers but has begun asking for larger deposits or payment on delivery from some buyers that appear risky. “We have to reassess each individual’s credit,” says Yoder, who confirms that in some cases Wood-Mode cut off credit to customers.
Longer payment terms are part of the “new normal,” says Joe Reini, president of Mason-Grey, a28-employee engineering services company in Atlanta. “It seems to me that ‘net 30’ [payinginvoices within a month] is gone,” he says. “Customers are now asking for 45, 60, even 90 or120 days.” About half his customers have sought longer payment terms, Reini says. MikeMitternight, president of a commercial air-conditioning contractor in Metairie, La., says nearlyhalf his accounts take longer to collect. So Mitternight’s nine-employee company, FactoryService Agency, has started to avoid suppliers that demand quick payment. “We’ve had to be selective and only work with manufacturers who will allow a little extra float,” he says. With receivables ballooning, he says, Factory Service Agency looks weaker to potential lenders and insurers who provide bonding needed for government contracts, making it “hard to expand and grow your business.”
The bottom line: Growing numbers of companies are caught between vendors demanding faster payment and customers taking longer to pay.
1. What is the accounts receivable turnover ratio? How is it calculated? What are daysoutstanding and how is it calculated? How is it used?
2. How does increasing receivables and decreasing payables correlate to a cash-flowsqueeze? How did the financial crises effect accounts receivable management?
3. What is the process of a firm to grant credit? How do they decide on a credit limit?
4. What is the credit extension process? Why would a firm decide on extension?