Understanding Cash Flow
“Many profitable businesses have gone broke due to a lack of cash.”
That statement often leaves business owners perplexed. How can a business be profitable yet face cash flow issues?
The simplest example is a business collecting money from its customers after paying its bills. Cash goes out before it comes in.
Many business owners encounter this situation when offering customer accounts or extending credit. If you’ve found yourself in this predicament, stay with me as we break down the difference between cash and accruals.
Cash Profit: Calculated based on the actual movement of money—when customers pay and when you pay your expenses.
Accrual Profit: Calculated based on invoicing—when you issue invoices and when expenses are invoiced to you, regardless of actual payment.
Grasping the nuances of cash flow is crucial for making the proper adjustments to keep your business financially healthy. Here’s how to wield the levers of cash flow management effectively.
Lever 1: Customer Payment Terms
In my experience, customer payment terms are the most impactful lever to improve cash flow, assuming profitability isn’t the issue.
Evaluate and Adjust Your Payment Terms:
Advance Payments: Collect payments before your obligations are due.
More extensive Deposits: Request more substantial deposits to cushion cash flow.
Shorter Terms: Shift to shorter payment periods like 7 or 14 days.
Invoice Fine Print Suggestions:
– Add a clause like: “In the event of overdue payments, administration fees and interest charges will apply.”
– Follow through by issuing administrative fee invoices if clients don’t comply.
Best Practices:
– Outline best practices for new customers.
– Adjust existing customer terms gradually to prevent client loss.
Lever 2: Supplier Payment Terms
Negotiate payment terms with suppliers that ensure you’re paying after you’ve received money from your customers. For instance, negotiate a 60-day payment period to give yourself ample time to collect.
Lever 3: Payroll Calendar
Your payroll calendar can significantly ease cash flow pressure. Here’s an optimal approach:
– Shift to a fortnightly payroll calendar.
– Pay on Thursday after the fortnight ends (Monday to Sunday).
Example:
– Switching from weekly to fortnightly saved a client over $7,000 monthly cash flow.
Advice for Implementation:
– Provide a 3-month notice period to employees.
– Offer loans or financial counselling to help them adjust.
Level 4: Inventory Days (Stock Turns)
Manage Inventory Days:
– Aim to sell inventory before supplier payment is due.
– Understand your inventory turnover ratio to optimize cash flow.
Success Example:
A furniture retailer increased stock turnover, extended supplier payment terms, and switched to a fortnightly payroll, resulting in $31,712 more cash in the bank.
Final Words: Secure Your Business Success
Cash flow management isn’t just an afterthought; it’s critical for business survival and growth. By optimizing these levers, you’ll improve your cash flow and secure your business’s future.
Contact Katia Chehade of Sudoku Bookkeeping for tailored advice and tools to improve your cash flow management.
Secure your business’s future today—because Cash is King!