The Investment Lesson in Groupon Killing Small Businesses

Groupon (NAS: GRPN) is killing small business.

At least that's the case if you believe the owner of Back Alley Waffles. The business owner ran an offer through the deal site, but the start-up waffle house/art studio went out of business because it had to pay the costs of serving the waffles upfront, but Groupon spread out the payments to the company over three months.

I'll gladly pay you Tuesday for a hamburger today
The metric Back Alley Waffles failed to pay attention to is days sales outstanding, or DSO:


DSO = Current accounts receivable / (Sales for period / Days in period)

The formula calculates the number of days it takes for a business to collect for products or services it's already sold. Accounts receivable is essentially an interest-free loan to the customer, so keeping DSOs low is key to a healthy cash flow.

Investors should keep an eye on DSO for the companies they invest in. Too many sales to the Wimpys of the world and any business will go under, no matter how big or small.

Keep in mind, though, that different industries will have different standards for their DSOs. Coca-Cola (NYS: KO) , for instance, had an average DSO of 36.7 days in 2011, while Pfizer (NYS: PFE) had a DSO of 73 days during the same period. Clearly Coca-Cola is better at managing its cash, but it has different types of customers with different demands.

Comparing companies within an industry is fair game, though. Eli Lilly and Merck (NYS: MRK) had average DSOs of 53.3 days and 59.3 days, respectively, trouncing Pfizer's ability to get paid quickly by its customers.

It's also helpful to check trends within a company. If a company can reduce its DSO, it can put its cash to work in other areas to grow its business. Pfizer's DSO was as high as 87.4 days in 2009, so at least the metric is headed in the right direction.

The flip side
While companies want to get paid for their services quickly, they also want to delay paying for things that they buy. That metric, days payable outstanding, or DPO, is calculated with this formula:

DPO = Accounts payable/Cost of goods sold per day

It's in Groupon's best interest to set up payment terms so it can hold onto the cash that it takes in before paying it out to the company it's running the offer for, because that allows the cash to be available to invest or pay other bills. In some industries, insurance companies for instance, investing customers' cash before paying it out is where much of their income comes from.

As long as you're not putting your customers out of business, of course
Which brings us back to the start of the article. Is Groupon putting its customers out of business?

Not directly, in the same way Wal-Mart is blamed for killing small business after moving into an area. I have sympathy for Back Alley Waffles, but no one forced the company to agree to the contract terms.

But indirectly? Maybe.

The company is in a tight spot since start-up businesses tend to be low on capital. In fact, according to the U.S. Small Business Administration, insufficient capital is one of the top reasons roughly 50% of small businesses fail within the first five years. Groupon has to tread lightly here if it wants businesses to be around to make another offer through the company again.

I've always had the same worry about payday lenders such as EZCorp, DFC Global, and Cash America. The occasional customer can afford to pay the high fees they charge on short-term loans if they're in a bind. But being a regular, repeat customer seems to be a recipe for financial ruin.

If Groupon can't afford to give small businesses better terms, maybe it needs to offer a cash-flow management course as a package deal with its offerings for small businesses.

This Fool is available to run the course. Just don't expect me to wait 90 days to get paid for it.

The article The Investment Lesson in Groupon Killing Small Businesses originally appeared on Fool.com.

Fool contributor Brian Orelli won't get paid for writing this article for a few weeks, but he's OK with that because he knows how to calculate DSO. He holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Coca-Cola. Motley Fool newsletter services have recommended buying shares of Pfizer and Coca-Cola. Motley Fool newsletter services have recommended creating a bull call spread position in Wal-Mart Stores. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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