Small Business Department
Cash is King!
By Alan Sartain
Cash is king when it comes to managing the financial health of a growing company. The traditional way of measuring cash is cash flow. Basically that means the difference between the cash you receive from your customers and the cash you must payout to your vendors. In an ideal world, you would ship your product to your customers as soon as your inventory arrives from your vendors (just in time or JIT) and your customers would pay you as soon as you shipped your product. Unfortunately, the world doesn’t work that way. You often find yourself between suppliers who are demanding quick payment and customers who are slow to pay.
If you look at the example, Joe from Joe’s Plumbing orders supplies that tend to sit on his shelves for 60 days. He then consumes the supplies during a service call and his customers take an average of 60 days to pay. In this case, the cash gap is 90 days.
So what is a cash gap and how do you reduce it? Quite simply, the cash gap is the difference between the time you pay for the inventory and the time you get paid by your customers. In Joe’s case, he was paid 120 days from the time he received the inventory but had to pay his vendor within 30 days. Therefore, his cash gap was 120 days minus 30 days or 90 days. How do you reduce your cash gap? There are really only three ways: 1) Reduce the number of days you carry your inventory, 2) Gain extended terms from your suppliers, and 3) Reduce the time it takes to get paid from your customers. Let’s explore each of these options.
The most overlooked, yet one of the most effective methods of improving cash flow is to simply improve your warehousing operation. By increasing your turns from six per year to twelve per year you will reduce your inventory from 60 days to 30 days. This way you will ship your products by the time you have to pay your vendors for them and reduced your cash gap by 30 days.
To ensure creditworthiness, you need to make certain that you pay your vendors in a timely manner. If you are unable to do so, you should contact your vendors to work out arrangements. Having said that, here are some tips to help you manage your payables. First, take full advantage of creditor payment terms. If a payment is due in 30 days, don’t pay it in 15 days. Next, use electronic funds transfer to make payments on the last day they are due. You will remain current with suppliers while retaining the use of your funds as long as possible. Finally, don’t always focus on the lowest price when choosing a vendor. Sometimes more flexible payment terms can improve your cash flow more than a cheap price.
Last, but certainly not least, you need to improve your receivables. If you are like Joe and it takes an average of 60 days to get paid by your customers. You are acting as a bank for your customers. There are many strategies to reduce your receivables but often the most effective is to simply pick up the phone, call your customer and ask for payment. Here are a few other well-tested strategies for improving receivables. Offer discounts to customers who pay their bills rapidly. Ask customers to make deposit payments at the time orders are taken. Require credit checks on all new customers before extending credit. Offer c. o. d. (cash on delivery) for all customers who do not meet your creditworthiness hurdle or who are slow paying. Issue invoices on the day the product is shipped, do not wait until the end of the month. One strategy I have used successfully in the past is to offer a sales contest but include in the rules that the customer must be current to receive a payment.
If you improve your inventory position, manage your payables and reduce your receivables you can reduce your cash gap from 90 days to under 30 days, freeing up more cash to invest in the growth of your business. Remember, cash is king!