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C2FO Powers Early Payment Programs for the World’s Largest Companies.
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Do you know your DSO from your DPO, or COGS from NPS? This quick, handy guide will help you navigate key aspects of your business’s finances.
If you’re like most entrepreneurs, you probably didn’t start your business because of a deep, abiding love for balance sheets and income statements.
Still, understanding basic finance and accounting terminology is essential for any small to midsize business owner. Knowing these terms can help you track cash flow, understand financing strategies and monitor metrics crucial for growth. Here are some useful terms organized by finance category for you to reference as needed.
Accounts payable is money that a business must pay a supplier or trading partner. An account payable is usually recorded on the balance sheet under short-term liabilities.
Accounts receivable is money that is owed to a company by a customer or a debtor. For example, if a business sells a product or provides a service, it records an account receivable for unpaid invoices that are due from that customer.
An early payment discount is a type of trade finance in which a customer pays a supplier’s invoice early in exchange for a small discount. In other words, an early payment discount gives customers an incentive to pay earlier than the agreed terms, allowing the supplier to increase cash flow.
Dynamic discounting is an approach to early payment discounts that adjusts the discount rate depending on how early the customer pays. With dynamic discounting, customers can pay at any time within the agreed term — but the earlier they pay, the bigger the discount they receive.
Invoice factoring is a type of financing in which a business sells its outstanding invoices to a third-party factoring company (a factor) to increase cash flow. Put simply, a factor advances 70% to 90% of the invoice total to the business upon receipt and collects full payments directly from the customer. Businesses typically enter invoice factoring agreements as long-term contracts.
A master service agreement (MSA) is a buyer-supplier contract that outlines the foundational, ongoing terms of a relationship. An MSA typically includes agreements such as payment terms, product warranties, intellectual property ownership, dispute resolution, geographic location and venue of law. The agreement is often used in long-term business relationships. It helps both parties avoid negotiating redundant terms for each purchase order.
Net terms describe how long a customer has to settle invoice payments. Net 30 terms are common, indicating that the customer has 30 days to make a payment. However, standard net terms vary by industry, with some as short as net 10 and others as long as net 60 or more.
A net promoter score is a customer experience metric that indicates the loyalty and satisfaction of a business’s customers. An NPS is regarded as a reliable customer service evaluation metric and is used by more than two-thirds of Fortune 1000 companies.
Customers provide a rating between 0 (unlikely) and 10 (highly likely), indicating how likely they are to recommend a business. An NPS score is calculated by subtracting the percentage of responses with a score between 0 and 6 from the percentage of responses with a score of 9 or 10. Scores range from -100 to +100, with positive scores considered acceptable.
A static discount is a traditional approach to early payment discounts in which the discount is offered at a fixed rate within a fixed timeline. For example, static discounts are typically expressed as “2/10 net 30.” This means that the customer receives a 2% discount if it pays within 10 days of the invoice date — otherwise, it must pay the full amount within 30 days.
The cash conversion cycle (CCC) is a key metric used to evaluate the efficiency of a company’s operations, indicating how long it takes to convert inventory investments into cash flow from sales. A low CCC signals a healthy cash flow. The CCC accounts for how long it takes the business to:
You can calculate your CCC by combining the above metrics in the following formula: CCC = DIO + DSO – DPO.
Cost of goods sold (COGS) expresses the amount of money required to produce and sell inventory. COGS covers direct inventory costs such as those associated with purchasing, conversion and distribution. By subtracting COGS from revenue, a business can determine its gross profit.
Days inventory outstanding (DIO) measures the average number of days a business retains inventory before selling it. DIO is used to calculate the cash conversion cycle. A lower DIO value supports a healthy cash flow.
Days paid early (DPE) measures the number of days between an invoice’s original due date and the date when early payment is received. DPE was coined by C2FO and is used to calculate dynamic discounting rates on C2FO’s Early Pay platform.
Days payable outstanding (DPO) measures the average number of days it takes a business to pay its suppliers for goods and services. DPO is used to calculate the cash conversion cycle. A higher DPO value supports a healthy cash flow, as long as the business doesn’t incur late payment penalties.
Days sales outstanding (DSO) measures the average number of days it takes a supplier to be paid for the goods or services provided to customers. DSO is used to calculate the cash conversion cycle. A lower DSO value supports a healthy cash flow and indicates that customers pay invoices promptly.
Earnings before interest, taxes, depreciation and amortization (EBITDA) is a common financial metric used to measure operating profitability before interest, taxation, depreciation and amortization are subtracted. Put simply, EBITDA describes a business’s cash profit before considering any depreciating assets. EBITDA is commonly used in industries where high depreciation or amortization levels may skew profitability metrics, such as the energy and technology sectors.
Generally accepted accounting principles (GAAP) include standard accounting rules and principles that all publicly traded companies in the US must follow when compiling and reporting financial statements. GAAP standards are dictated by the Financial Accounting Standards Board and include principles such as consistency, continuity and periodicity. GAAP standards ensure that businesses’ financial data is complete and easily comparable, facilitating investment and trend analysis.
Working capital describes the value of a business’s day-to-day trading operations and is calculated by subtracting current liabilities from current assets. Current assets include cash, inventory and outstanding invoices, while current liabilities include debts and accounts payable. Tracking working capital helps a business understand its short-term liquidity and financial health.
Alternative financing is a blanket term used to describe financial channels, processes and products that fall outside of the traditional financial system, which includes banks and capital markets. For example, supply chain finance, invoice factoring and early payment discounts are all alternative financing solutions that can fund businesses without using traditional institutions.
An annualized percentage rate (APR) is an expression of interest or cost of funds over an entire year rather than expressing interest as a monthly fee or rate. APR provides a more transparent view of overall borrowing costs and, because it’s widely used, makes it easy to compare the cost of different financing products.
C2FO uses APR to calculate dynamic early payment discounts, which award customers with a bigger discount the earlier they pay an invoice. For example, a 12% APR offer would give customers a 0.03% discount for each day they pay early (12%/365 days = 0.03%).
Asset-based lending is the practice of securing a loan with a business’s assets, such as property, equipment or unpaid invoices. In other words, if the business is unable to make loan payments, the lender may seize the business’s assets. Asset-based lending reduces risk for lenders and is often used by businesses that lack the cash flow or credit history to qualify for unsecured loans.
A business line of credit is a form of revolving credit that gives borrowers access to funds at a predetermined limit. Similar to a credit card, borrowers can draw funds at any time. The borrower pays interest only on the amount of cash used, and the credit balance replenishes when funds are repaid. Business lines of credit are often used to cover short-term business expenses.
A lien is a legal right against an asset or property that is used as collateral for a debt or other obligation. The property owner who grants the lien is a lienee, and the lien holder or lienor benefits from the lien. Similar to asset-based lending, a lien means that the lien holder may seize an asset if financial obligations, such as loan payments, are not met.
A prime rate, prime lending rate, or simply “prime,” describes the interest rate charged by banks to their most favored customers — those with the best creditworthiness. The prime rate is used as a benchmark for interest rates among various financial products such as business loans and lines of credit. Businesses and consumers that don’t qualify for the prime rate typically receive an interest rate expressed as prime plus an additional percentage.
Short-term business loans are lump sums provided to a company to cover short-term expenses such as inventory, cash flow shortages or unexpected costs. Borrowers can pay off loans in monthly, weekly or daily installments over three to 36 months. Because short-term business loans are intended to cover immediate expenses, they’re often easier and more efficient to secure than other business loans.
The Secured Overnight Financing Rate (SOFR) is the interest rate pricing benchmark used for derivatives and loans in US dollars. SOFR replaced the London Interbank Offered Rate (LIBOR) in June 2023, which until then had been the go-to benchmark interest rate for banks and investors. Unlike LIBOR, the SOFR rate is based on actual Treasury transactions rather than rate estimates.
The Sterling Overnight Interbank Average (SONIA) is the interest rate pricing benchmark used for off-hours trades in the British sterling market. SONIA provides a benchmark interest rate for short-term, unsecured loans with minimal risk. It was established by the Working Group of the Bank of England in April 2017 as the preferred risk-free rate in sterling markets.
Supply chain finance (SCF), also called supplier finance or reverse factoring, is a financing solution that buyers use to fund early payments to suppliers. In a typical SCF program, a buyer partners with a bank or fintech lender. When suppliers submit invoices, the lender pays suppliers early in exchange for a discount and the buyer pays the lender back in full within an agreed term. Supply chain finance is intended to help both buyers and suppliers build working capital and strengthen supply chains.
A variable rate discount is an interest rate that fluctuates based on a lender’s standard variable rate (SVR). The lender sets an SVR, which it can change at will regardless of other benchmark interest rates. The borrower’s interest rate is set at a certain amount below the SVR, and this discounted rate increases or decreases alongside the SVR. Variable rate discounts can result in a more competitive interest rate, but because rate changes are governed by the lender, they are also less predictable.
This article originally published September 2020, and was updated July 2023.
In this article:
Nearing the end of your fiscal year? Businesses can benefit from a year-end accounting checklist to navigate the process smoothly.
Understand the differences and similarities between reverse factoring and supply chain financing so you can find a solution that fits your business’s needs.
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