A lot has changed in the 25 years I’ve spent consulting with small businesses, but at least one thing hasn’t. Cash really is king. Running out of cash is still the definition of failure in business.
The basics of cash flow 101 are what keep a business alive. Cash should be managed with the care and attention it deserves. No cash means no business.
What do you expect your cash balance to be six months from now? Contemplating that one question may change the way a business is managed. Let’s consider a few points to help address that query. Cash flows through the business. Businesses generate cash, and they use cash. It’s a continuous cycle. Speed is a key ingredient to the cash cycle — speed up the cash in and slow down the cash out. In terms of accounts receivable, billing quicker and collecting quicker will speed up cash inflows. Factoring may also be an option to explore.
Conversely, delaying payment on accounts payable as long as possible without incurring late fees will slow down the cash outflows, keeping precious cash in-house a little longer.
Every penny tied up in inventory is cash tied up. Inventory is cash that could be used to generate cash elsewhere. And that inventory can sit there for long time. Think about dropping (at least temporarily) any products that are tying up cash long term.
Consider this example. What if a product is bought on account and paid for in 20 days? Then it sits in inventory 90 days before it sells — on account — and then the cash from the receivable is collected in 60 days?
Taken together, those three areas make up the cash conversion cycle and equate to 130 (90+60-20) days — more than four months without that cash.
What if we manage our cash a little better?
Let’s say that through better management of inventory we reduce products sitting in inventory from 90 days to 60, collect the accounts receivable in 30 days instead of 60 and increase the bill paying delay from 20 days to 30.
The cash conversion cycle then changes from 130 to 60 days. That’s 70 days the cash could have been invested elsewhere, making the business money.
Debt is another area that affects cash flow. Paying debt down quickly is a commendable goal, but paying down debt too quickly burns cash. It’s admirable, but the business must be able to withstand the extra outflow of cash.
Consider pricing a moment. Most businesses want to sell, sell, sell to generate cash, which is great. But they typically want to sell cheap, sell cheap, sell cheap. That can be a car wreck about to happen. Reducing prices may very well be the answer, but then again, the answer to the cash flow issues may be to raise prices.
If a company’s gross margin is 30 percent, and the business decreases its prices by 5 percent, it must increase its sales by 20 percent in order to maintain the same gross profit level.
On the other hand, the same company can increase its price by 5 percent and withstand a 14.29 percent decline in sales and maintain the same gross profit. Thus, if the price increase is made and sales drop 5 percent, or even 10 percent, the business has generated extra cash.
Good cash management is crucial to maximizing the success of a business, and these are but a few of the many cash critical areas in which the Georgia SBDC Network can help businesses to excel.
David Dunn is a Business Consultant in the Albany office of the Georgia SBDC Network and he may be contacted at email@example.com.