A Business Rule of Thumb: Buy On Credit, Sell For Cash
Success in business does not happen by sheer accident. It happens because the entrepreneur who owns and runs the business strives to adhere to business rules of thumb, which greatly increase the likelihood of success. One such particular rule of thumb in business is Buy on Credit, Sell for Cash.
A business needs sufficient capitalization in order to survive. This is especially true if the business is capital intensive, just like businesses that deal with merchandise and production. Businesses in the manufacturing industry, for example, will require sufficient capitalization so that it can purchase raw materials; and raw materials can sometimes be very expensive, all the more if they are sourced from outside the country.
Wise entrepreneurs know how to deal with this challenge; they apply or use the business rule of thumb Buy on Credit, Sell for Cash.
How Does this Rule of Thumb Work?
Let’s have an example of a simple business transaction between an entrepreneur who owns a manufacturing business, Mr. A, and a businessman that sells raw materials, Mr. B.
Mr. A went to see Mr. B and expresses his desire to purchase raw materials on credit. Mr. B agreed and gave Mr. A 60 days to settle his accounts payable.
The transaction is mutually beneficial: Mr. A got his raw materials on account for 60 days, and Mr. B. was able to sell his raw materials. Assuming that Mr. A will be true to his commitment and pays Mr. B on the 60th day, both of them will have made money out of the transaction, which is the very purpose why they are in business in the first place.
However, the best question to ask is this: between the two businessmen, who made the most money out of the transaction?
Following the business rule of thumb above, it would be safe to say that Mr. A got more out of the transaction than Mr. B.
Here’s what happened.
Mr. B, when the transaction was completed, will have to wait for 60 days to finally be able to say that he made a profit.
Mr. A, on the other hand, upon taking hold of the raw materials, proceeded immediately to turn the raw materials into the finished product. Let’s just say that, within 7 days, most of the raw materials have been converted into finished products. Then, the finished products left the production line and went directly to distribution. Two more days and most of these products would have reached the store shelves. These finished products are then sold for cash. Within 10 days from the moment the raw materials were bought on credit, they were turned into finished products, sold, and money came in to Mr. A. The beautiful thing about the whole transaction is that Mr. A still has 50 days or even 40, to use his earnings from the raw materials he bought on credit. He can use it to purchase more raw materials, pay his bills, or practically just add it to the cash flow of the business, until such time the 60 days accounts payable becomes due. In simple terms, he is able to use Mr. B’s money on his business within the 60 days period.
Business Rules of Thumb really works. They are business practices that are tried and tested by many successful businessmen, or more aptly, by entrepreneurs. Thus, to succeed in business, an entrepreneur can do well to learn from other successful businessmen’s experiences.
Another rule of thumb in business is to separate personal expenses from business expenses. You can do this by applying for a credit card for your business alone. Before diving into this, however, make sure you compare credit providers to get the best offers.
