If you understood the basics of accounts receivable and accounts payable and you could comprehend the relationship to performance, then here’s a boomerang to consider as you’re dodging as much confusion as possible. How can a company have millions of dollars in just accounts receivable or just accounts payable and succeed?
Try not to let your head split, but there are several reasons why companies may have massive balances for accounts receivable or accounts payable. It could be a seasonal cycle, maybe a bulk purchase, potentially companies merging, or it could all come down to lenient customer credit policies (cough, cough, Amazon). Maybe it’s a red flag, or maybe it’s an outlier. Let’s talk about it!
What Are the Factors that Make Outliers for Accounts Receivable?
Remember that accounts receivable (AR) is money customers owe and will pay back to a company. If a company has massive AR, there are context clues surrounding the company that show what’s going on.
- Sales on Credit: – When a significant portion of a company’s sales is handled through credit, it can result in a large AR balance.
- Seasonal Sales: – Cyclical fluctuations mean AR will be higher in specific periods of the year. For example, retailers have higher AR during the holidays because everyone buys gifts.
- Customer Credit Policies: – When a company has lenient credit policies, they attract customers with poor payment history; this combo increases the chance of late fees and even bad debts, which make high AR.
- Longer Payment Cycles: – Specific industries model longer payment cycles that increase AR. For example, construction projects are paid in milestones over a period of time because of the length of any given contract, which reflects in high AR.
- Customer Base: A large, loyal customer base will naturally create significant AR. Think of a trendy water bottle brand or Taylor Swift. Money, popularity, and loyalty mean a high AR.
What Are the Factors that Make Outliers for Accounts Payable?
A company has massive AP (accounts payable), meaning they have to pay back money that they owe, which only sounds like a negative situation. However, below are several reasons a company might have a massive AP.
- Supplier Relationships: – A good relationship with a supplier can mean generous payment terms leading to large AP. An extended payment period allows a company to access its liquid assets readily, creating high AP.
- Just-in-Time Inventory: – A management practice that relies on specific delivery times so they don’t overstuff inventory storage while still fulfilling customers’ needs. Large AP means they pay suppliers when they receive and account for the inventory, not when they initially order it.
- Bulk Purchases: – Bulk purchases and long-term contracts could lead to large AP balances, which plays into the efficiency of getting discounts and favorable pricing terms.
- Working Capital Management: – When working capital is managed to optimize AP by maximizing payment terms to have a cash flow that will support other operations, which is a form of efficiency
- Mergers: – When companies merge, the process can inflate payment terms, which increases AP, but only for a temporary time frame.
Are There Successful Companies with High Accounts Receivable?
Yes, there are, and a successful company with a high AR indicates a particular industry or sales method. Picture a dominating telecommunications company that offers a mobile phone plan to customers. The sales process might look like this:
- The customer picks a plan and subscribes.
- He/she is billed monthly for service charges and additional usage charges.
- Payment terms are typically 30 days, and the account’s activity in the 30 days is recorded as AR.
- The customer pays, and the company reduces AR to the correct balance.
The dynamic between a customer continuing to use the phone services within a billing cycle while waiting to pay them reflects on the company as a high AR. This example is one of several thriving industries and business models with massive AR.
Are There Successful Companies with High Accounts Payable?
It might sound tricky for a company to be profitable with massive AP, but the answer is yes, there are strategies for investing money and then paying off accounts that help companies succeed. Imagine a groundbreaking e-commerce company (it rhymes with Glamazon) with a bazillion suppliers and vendors making up its inventory. The operations with one of the suppliers might work like this:
- The company negotiates contracts with a supplier, including an extended payment cycle.
- After the contract is settled, the company places an order, and the order is delivered.
- The company functions on Just-In-Time Inventory with an extended payment cycle, allowing for flexibility with its cash.
- Before paying the supplier, the cash flow from that supplier’s product is used for other operational investments.
- Finally, the company fulfills the contract after capitalizing on the extended payment cycle.
This strategic approach can create a massive AP. Still, the timing mismatch between collecting revenue and making payments to suppliers allows the company to preserve cash flow, giving the flexibility to grow initiatives, meet operational needs, or invest. It sounds crazy, but it works!
How Can Equities Lab Help You?
Not only is Equities Lab giving you all the ins and outs of financial terminology, building a foundation with relevant information, and providing context for the outliers, but it’s all on top of powerful software you can harness. Don’t be overwhelmed if you’re still maneuvering the dodgeballs coming your way. The strategies to help maintain your sanity and maneuver the market are readily available!