- Let's talk about receivables management.
We want to manage our receivables
to ensure that they turn into cash in a timely manner.
Now why would any company have receivables
in the first place?
Why not just sell for cash?
Credit sales are an age-old marketing technique.
If we offer credit to our customers,
we will get more sales.
If I'm offering a product and insist you pay cash,
and my competitor down the road
is allowing you to pay in 30 days for the same product,
you are likely to go to my competitor.
So if selling on credit increases sales,
why not offer credit to everyone?
Well if you offer credit to anyone and everyone
without conditions or credit checks,
there will be a lot of people
who will buy on credit but will never pay.
The anticipated cost of these bad debts
is a trade-off to the increased sales
from selling on credit.
I've got to measure that trade-off
to ensure that those increases sales are worth it.
In addition, there's an added bookkeeping cost
associated with selling on credit.
You have to keep track of who owes you,
how much they owe you,
and you've got to send them regular bills
to ensure that they pay you.
Also, by tying money up in accounts receivable,
I lose the opportunity to use that money
somewhere else in my business.
For example, in 2017, Boeing had accounts receivable
of $10 billion.
If Boeing had that $10 billion in cash
rather than as receivables, they could invest it
or pay down their outstanding loans.
In summary, in managing accounts receivable,
the increased sales that come from selling on credit
must be compared to the cost of bad debts,
increased bookkeeping, and the lost use of money
because your cash is sitting in your customers' pockets.
Now let's consider inventory.
Why have any inventory at all?
Well, if somebody walks into your store
and you don't have the product they want,
they'll go elsewhere,
and they may never come back.
Companies carry inventory to ensure
that when a customer wants a particular inventory item,
they can find it on our store.
So then why not have a huge inventory
to make sure that you can satisfy the needs
of every possible customer?
Well there are costs associated with having inventory.
As with accounts receivable, if our money is tied up
in inventory, it is not available to be used somewhere else
such as in paying down existing loans.
When it comes to inventory, we have to implement
the goldilocks principle:
not too much and not too little.
We want to make sure we have just the right amount
of inventory on hand.