I’m just starting out with my own business, importing clothes and jewelry from Jamaica, and just had someone ask how I do “invoice aging”. What the heck is invoice aging, Dave, and why would I want to do it?
It’s pretty easy to explain invoice aging, actually, but we should probably be sitting at a table in Vegas for the explanation to really make sense. Here’s the basic idea:
Let’s say that today I do some work for you and hand you an invoice on the spot. Do you pay me immediately, or do you let it sit for a few days – or longer – until you get to it?
That process of ‘letting it sit’ is what invoice aging is all about and it’s one way that companies “play the float” and manage their cashflow. For example, many big corporations have a policy that they pay “net plus sixty”, which means that they’re going to let your invoice sit and “age” (think wine) for two months before they issue a payment, even if you have written on it “payment due net plus 14″ or similar.
Most companies pay on a thirty day cycle, so if I handed you an invoice today, I’d be unsurprised if it took a month to pry the money out of your hands.
Why do this, rather than pay promptly? Well, let’s say that your business is really rockin’ and you’re selling a million dollars in goods each month. Your cost of goods (what we back in MBA school called COGS, or cost of goods sold) were $350,000 and you had invoices from your suppliers for that amount.
Now let’s assume that you have your business accounts in an interest earning money market account that pays, oh, what works out to be 2.5% interest on a daily basis (though interest payments aren’t usually calculated daily, but we’ll ignore that for simplicity). That means that each day you don’t have to pay out that $350,000 in invoices, you actually earn $8,750.00. Now you can see where paying invoices in 14 days will actually cost your company a cool $122,500 in interest revenue.
Suddenly invoice aging sounds pretty good, doesn’t it?
Of course, some companies – notably Fortune 500 companies who shall remain nameless – push aggressively on this and I know of at least one firm that does 90 day aging, which might be really good for their bottom line but stinks for vendors and suppliers. I mean, why not just stiff your suppliers completely if you’re going to wait three months to pay an invoice? But that’s another discussion.
In general, invoice aging is a common accounting practice and 30 days is a very common “age” for paying invoices and debts for a business.
Hope that clears things up. Good luck with your import business!