A big boost in sales seems like a dream come true, but there can be a cash-flow sting in the tail. Here’s how to manage increased sales growth like a pro.
An age-old question we get asked by business clients is “How come I’ve made more profit but I don’t have any more cash?” The answer to this question can be found in the ‘Cash flow cycle’.*
The ‘Cash flow cycle’ is an issue often overlooked by small business owners until business starts to grow and they begin to experience ‘cash flow squeeze’.
The Cash flow cycle diagram shows:
- Before you can sell anything you have to buy something. For example stock or labour.
- Depending on your sales cycle i.e. how long the stock sits in store, you may hold onto stock for 60 days.
- Depending on the terms you get from suppliers you may have to pay for that stock after 30 days, which means you have 30 days negative cash flow.
- Depending on your accounts receivable management, you could wait 60 days to get paid, which adds another 60 days negative cash flow.
- This adds up to 90 days negative cash flow.
This means your money has been somewhere other than your bank account (i.e. in the bank account of your supplier or customer) for 90 days. This is referred to as ‘funding the sale’. This is also known as ‘working capital’, which means you need to have a certain amount of money to fund sales all the time.
It’s a tricky situation that causes a problem when growth occurs because the issue just gets bigger. If a business isn’t working to minimise the number of days stock is in store and the number of days customers are taking to pay, then the problem becomes exacerbated as sales grow.
This is why growth can often kill what appears to be a good business.
So before your business gets very focused on increasing sales, it’s important to ensure the issues of stock movement and accounts receivable are not ignored.
If you operate a service-based business and think you’re immune from the above, think again. Having a large chunk of ‘work in progress” can cause cash flow squeeze if billing and payment terms are not well managed.
It pays to calculate a billing and payment program with customers that takes into consideration the payment for materials and labour on a job. Ideally you’d ask for a decent deposit up front to cover as much of material costs as possible, then schedule regular, progressive payments to cover labour.
If you are planning to grow your business it’s important to get an understanding of the cash-flow process ahead of time as it’s easier to avoid cash flow problems than it is to correct them!
A cash flow statement can be one of the most important tools in managing your finances. It tracks all the money flowing in and out of your business and can reveal payment cycles or seasonal trends that require additional cash to cover payments.
Give us a call or make an appointment to discuss how we can help you overcome potential cash flow issues before they become a problem in growing your business.