Mr. mehra has a problem which he considers rather unique but the fact is otherwise. He is into business of supplying home furnishings. He would source unique materials and finished goods from around the country and the world. He knows that his business has the potential to generate a clear profit margin of 30 per cent. This he thinks is the best investment for him and in my view his decision was quite alright.
With his business acumen he successfully won contracts with many retail chains, malls and supermarkets. But whenever he looked at his bank account he felt he was always left with practically nothing. Where had his 30 per cent profit disappeared? Something was seriously wrong somewhere. This is also quite the situation with many people and it has nothing to do with whether you are in business or in salaried.
Mehras problem is not only of cash management; there were, in fact, four distinct problems:
1. Cash management was the primary problem. When there is money just spend as you like. This ultimately creates quite a mess and for Mehra he would have to pay in 30 days for whatever stocks and material he bought but would only receive his payment in about 90 days.
2. Business was good and orders were flowing in so he wanted to take advantage of all of them, far beyond his financial means. This is just like a salaried person wanting to take advantage of opportunities to buy things when they are available at a good discount. He started to book new business by taking more credit and at higher costs.
3. To fund the business momentum he would blindly take loans, use overdraft facility and bear interest cost in the range of 12 per cent to 20 per cent. He could afford to do this as business was generating a minimum of 30 per cent returns. This is akin to people taking on large EMI commitments thinking that their high income will always continue.
4. Blind faith on his customers payment cycle as he was dealing with very big names. This is the most lethal.
What if the payments did not come in time? What he failed to realised that if his business was growing it was due to the growth the retailers business. As it turned out the retailer was buying more real estate and thus increased its credit period with