Timing is everything – and when it comes to financial float it so happens that time actually is money.
The term “float” can refer to several different financial concepts. For business leaders and managers, one of the most important is the time lag between when accounts receivable are collected from customers and when accounts payable are paid to suppliers. Managing that dynamic is a critical element of a company’s financial strategy, affecting cash flow and liquidity, working capital, and short-term financing decisions.
The benefits of float can lift a company’s cash level like a rising tide; General Electric freed up $3.8 billion in cash in a single quarter through financial float. Conversely, U.S. Bank estimates that 82% of small business failures are due to poor cash management.
Here are some ideas that have been floated about financial float:
- The overall principle is to collect quickly and to pay slowly – without upsetting anyone at either end too much.
- Receivables float: The time it takes for a company to actually receive cash from customers after providing a product or service. For example, does the company allow customers to pay in 30 days? 60 days?
- Companies try to keep receivables float as brief as possible while still offering reasonable payment and credit terms. The shorter the receivables float, the better a company’s liquidity position can be.
- Every day that a company does not receive cash owed to it from customers is a day that the company needs to find other sources of cash for its operations. And that can include expensive short-term financing, a concern in today’s rising-rate environment.
- Payables float: The time it takes for a company to pay its suppliers after receiving a product or service. Including the time between when the company makes the payment to the supplier and when the funds are cashed and cleared.
- Longer payables float provides a company with a temporary source of cash before actually paying their bills (a.k.a., using other people’s money).
- Interest can be generated from holding that cash, if only for a short period of time, particularly as interest rates float upward.
Receivables/payables float is just one type of financial float: Berkshire Hathaway skillfully manages insurance float to rise above the competitive quicksand; and the Federal Reserve includes check-clearing float as part of their monetary reserve balance figures. PriSim’s business simulations include both receivables/payables float and insurance float dynamics.
While a company might float like a butterfly, it should also watch out for bees – if a company doesn’t pay when due, it could wind up anchored to a federal prison. The FBI describes insurance premium diversion, a form of payables float in which a drowning insurance agency siphons off carriers’ premiums, as the most common type of insurance fraud.
Companies can use the power of float to undock their cash, buoy their financial results, and to stay afloat. But hold the root beer and ice cream…