When you invoice your customers, you expect to be paid according to the payment terms specified. If your terms are net 30, you expect to be paid within 30 days. This doesn’t always happen. If a customer does not pay the full amount of the invoice within this window, you have a delayed payment. Delayed payments make it difficult to plan, and when you can’t estimate when you’ll actually receive cash, it is hard to make a strategy about how much money to spend and when you’ll have the cash to spend.
When you start planning for future periods, create two budgets: an operating budget and a cash flow budget. First, an operating budget outlines what you earn and the related expenses. Your annual operating budget may show $100,000 of revenue, $75,000 of expenses, and $25,000 of net income. Second, a cash flow budget looks at the timing of when your operating plans happen. You may earn $10,000 in January for services rendered but don’t expect your customer to pay until March. You may record a $4,000 expense in February but aren’t obligated to pay the bill until March. In this example, your cash flow budget shows $6,000 even though no revenue or expenses are recorded in this month.
If you notice you’ll be short on cash in upcoming months, you have options. Building a cash reserve gives you flexibility during months of lower cash inflow. Establishing a line of credit gives you flexibility and security as well. Negotiate payment terms with vendors; you may temporarily extend a 2% payment discount if your customer can pay an invoice within a week. By being prepared with an operating budget, cash flow budget, and alternative sources of cash, you overcome the challenges that arise when your customers pay late.