Managing Cash Flow Problems

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Are you having problems managing your business’s cash flow? Short of borrowing money, which I do not recommend, what can you do to improve your company’s cash position? Here’s some suggestions.

You can regain control of your financial situation by examining several areas of your business. The first area to look at is purchasing. You can conserve cash by buying smaller quantities of supplies more frequently instead of buying them all at once. The best time to buy in bulk is if a significant discount is offered. And when it comes to payment, negotiate with your vendors to get the best possible terms. You should pay early if offered a price break for prompt payment; otherwise, bills should be paid on time.

You can put the same concept to work with your customers by offering a discount for paying invoices early. If a payment is late, though, consider charging an extra percentage on the invoice. Billing customers immediately after your company ships merchandise may help speed up cash receipts. Also, any customers who regularly make late payments should be switched to COD.

Another area to look at is inventory. You should attempt to return slow-moving inventory or mark it down so that it will sell. You can avoid overstocking new purchases by carefully planning the quantities that need to be kept on hand.

A review of operating expenses can help you find ways to cut costs on overhead items, such as insurance and telephone and Internet service. To reduce taxes, consider making any equipment purchases before year-end if your business will be able to write off the cost on the current year’s tax return.

Good cash management is essential to business prosperity. If you would like to learn more about developing or improving your financial management system or discussing how the CommonSense System of financial management can improve your cash management, email me at info@commonsensecfo.com or call Kirk at 402-658-7340.

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Internal Reports

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As your business grows, it will inherently become more complex. It will eventually outgrow your capacity to be involved in every single detail of the business. There are just too many customers, employees, products, projects, vendors, and suppliers to be involved with.

As you become more removed from the details, you may feel a loss of control and may likely struggle to know how your business’ cash flow and profitability are really performing. You have to rely on reports with lots of numbers and data to understand how your company has done and make the best decisions possible for future success. (1)

The transition from a startup to a booming company is often difficult for founders and entrepreneurs. You have to re-train your intuition to process reports and data rather than talking to your employees and customers and reviewing the bills from your vendors and suppliers. While you should still engage in getting information from these qualitative sources, quantitative data will become more and more important to you as your company grows. Generally, quantitative data measurements should cover both the past and future on a daily, weekly, monthly, quarterly, and annual basis.

Daily Reports

Find one to three measurable pieces of information that can be reported daily. The items included on the daily report need to adequately allow your management team to answer this simple question: “Did we win or lose today?” Examples include gross profit per day, daily units sold, billable hours worked, backlog, among others. In addition to reporting actual performance on a couple of critical ratios, thriving companies need to know what tomorrow will look like. Measuring performance is not the reason to be in business, but it is critical to running your business effectively.

Weekly Reports

Develop a weekly report that highlights between 12 to 20 data points, with at least one or two coming from each of the critical areas of your business: marketing, sales, operations, finance, etc. These might include number of leads, leads converted to sales, revenue, revenue per employee, number of employees, percentage of receivables past due, working capital, current ratio, and more.

Besides knowing how the business did last week, this report should also project the company’s performance on these key numbers for the week to come. Also look at an updated cash flow projection (at least 6 weeks into the future) each week so your company can adequately plan for and adjust to cash flow shortages and excesses.

Monthly and Quarterly Reports

It is also important to have monthly and quarterly financial and operational reports, which include monthly financial statements. The monthly financial statements should include comparisons to prior years and months in the business as well as to industry averages and benchmarks (if available). It’s also important to review key trends over the past 13 months. Performance relative to your company’s plans and budgets, as well as projections for the next month and year, should also be included and analyzed. It is prudent to pay particular attention to validating and invalidating assumptions, and then improving them from month to month. Similar reports need to be reviewed on a quarterly basis, but are typically more summarized and should include lots of charts and graphs for quick review and presentations.

Annual Reports

You should revisit your five-year financial model and plan on a yearly basis. This includes a careful assessment of all of the assumptions that went into the model and updating those assumptions based on the actual performance of your company. Many business owners/managers fight this activity because they feel it is too hard to project five years into the future. While it is certainly difficult (and I have yet to see anyone that has projected their business performance perfectly for five future years) the exercise always yields helpful information to build a more competitive and sustainable business.

Developing appropriate and timely periodic reports and procedures is essential for business prosperity. If you want know more about establishing processes for all of these critical past and future reports, or if you want to learn how a part-time, virtual CFO can help transform your business using the Bible as our guide, email me at info@commonsensecfo.com or call Kirk at 402-658-7340.

(1) Be diligent to know the state of your flocks, And attend to your herds. Proverbs 27:23 (NKJV)

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Cash Gap

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Do you know your business’ Cash Gap? If you do, I applaud you. It is my experience you would be the exception. If you don’t, I encourage you to read on and begin to implement this important metric.

The Cash Gap refers to the time interval between the date when a company pays cash out for the inventory it purchases and the date it receives cash from customers for the same inventory. It involves three different financial measurements: the Receivables Period, the Days in Inventory, and the Payables Period. The formula is as follows: Receivables Period + Days in Inventory – Payables Period = Cash Gap (in days). The longer the time interval, the greater the likelihood it must be financed – which adds business risk and reduces profitability via interest expense.

The Receivables Period

The Receivables Period represents the average number of days it takes to collect invoices from your customers. This is typically calculated as Accounts Receivable divided by Average Daily Sales (annual sales divided by 365 or monthly sales divided by 30). For example, if your accounts receivable balance is $200,000 at the end of the year and your sales for the year amount to $3,650,000, your Receivables Period is 20 days [$200,000/($3,650,000/365) or $200,000/$10,000].

Days in Inventory

The Days in Inventory represents the average number of days worth of sales are in the inventory your currently have on hand. This is typically calculated as 365 days (or 30 days if that is your measurement period) divided by inventory turnover. Inventory turnover is typically calculated as cost of sales divided by average inventory. For example, if your cost of sales for the year amount to $2,400,000 and your average inventory (beginning inventory plus ending inventory divided by 2) is $400,000, your inventory turnover is 6 times. Your Days in Inventory would be 61 [365 days divided by 6 (inventory turnover)].

The Payables Period

The Payables Period represents the average number of days it takes to pay your vendors for your inventory. This is typically calculated as Accounts Payable divided by Average Daily Purchases (annual purchases divided by 365 or monthly purchases divided by 30). For example, if your accounts payable balance is $125,000 at the end of the year and your purchases for the year amount to $1,825,000, your Payables Period is 25 days [$125,000/($1,825,000/365) or $125,000/$5,000)].

Given the circumstances of this example, your Cash Gap would be calculated at 56 days (Receivables Period of 20 days plus Days in Inventory of 61 days minus Payables Period of 25 days). In other words, you are paying for the inventory 25 days after receiving the invoice but not collecting the receivable until 56 days later. Next, I’ll discuss ways to improve your Cash Gap, reduce your risk, and improve your profitability.

Knowing and understanding your Cash Gap is a great way to reduce your risk and improve your profitability. If you would like assistance in analyzing your company’s Cash Gap, or if you would like to learn how a part-time, virtual CFO can help transform your business using the Bible as our guide, email me at info@commonsensecfo.com or call Kirk at 402-658-7340.

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