Reduce the ‘cash gap’!
Let me just illustrate this, briefly. By the way, I know that not all businesses carry stock, so if yours doesn’t, just ignore the stock aspect of what I’m about to say.
Imagine that you buy stock today (let’s call it ‘day zero’) and that your supplier kindly gives you 30 days credit – so you’re going to pay for that stock on day 30. You sell the stock to a customer 15 days from now – and your customer then takes 60 days to pay. So you receive the money from the customer on day 75.
So, you pay for the stock on day 30 – and then get the cash in on day 75; that’s a 45-day ‘gap’ between paying your supplier and your customer paying you and your business will need funding to cover this. You’re ‘cash flow negative’ here for 45 days. The official term for this is ‘cash operating cycle’ – in this case, your cash operating cycle is 45 days. Now, here’s a sobering thought; the more of these transactions you do, the more 45-day ‘intervals’ you’ll have to fund – and the bigger the pressure will become on your cash flow. What this means is that the faster your sales expand, the quicker you’re going to run out of cash! It explains why some businesses can be highly profitable yet run out of money.
In an ideal world, of course, you’d be getting the cash in from customers before you had to pay it out; this way, instead of you needing more and more funding as your sales grow bigger and bigger, you’ve got yourself a cash-making machine!
In our example, if you could hold stock for just 5 days instead of 15, negotiate terms with suppliers to pay them on 45 days instead of 30, and get customers to pay on 30 days instead of 60, then you’d be collecting the cash on day 35, but not paying for the stock until day 45 – and that’s what I mean by a cash-making machine! In this case, your cash operating cycle is minus 10 days!
What an enormous difference that would make to your business model – and it’s something that will be particularly attractive to a buyer; so work on achieving quicker stock turnover, better credit terms with supplies, and improving credit control over your customers – these three activities, combined, will all help reduce and perhaps eliminate your ‘cash gap’.