Small Business Development Blog

Improve Cash Flow - How To Decrease Inventory or Work In Progress Period

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• Increase payables period
• Decrease collection period
• Increase inventory turnover/Decrease WIP period

Now it's time to focus on the third and final area; Decreasing Your Average Days Of Inventory and/or Work In Progress (WIP). With Inventory and Stock, it is actually very simple to see where you can improve. With WIP, this area represents a huge area of opportunity for some businesses. Click through, print, read, learn, implement and get results today.

The Inventory / WIP Period Clarified

Looking at our visual aid below we can see that in this case we brought some stock and it sat on the shelf for 60 days until a sale was made.

Now, most businesses that sell stock of some sort won't just have one item, they have many, so this measure, ‘Average Number of Days to Sell Inventory', is just that an average. Bring the average down and you'll reduce the number of cash gap days, putting more money in the bank.

WIP Days is similar; it's the difference between when you make the sale (or start the work) and complete the work. When you complete work you can invoice the full amount and get payment, if you let the project drag on you'll not get payment until later. The quicker this period the faster an invoice becomes due, the faster cash hits your bank account. Typically WIP might have two or three cost components, i) Labour, ii) Parts or Stock, iii) Raw Materials. If there is no thought that goes into the management of this process quickly you can end up accepting heaps of work and taken on lots of work and starting lots of work. But many businesses only get paid when they finish the work, so GET IT DONE, GET IT COMPLETED, GET IT OUT THE DOOR, GET IT SIGNED OFF, GET URGENT!!!

The dirt on your Inventory

Step 1) Discover where you are at by Measuring;

• i) the Inventory Turnover Rate

= Cost of Goods Sold / Average Inventory
eg = $650,000 / $106,908
     = 6.08

The higher the number the better! Each industry has an average and if you have a good accountant they should be able to tell you or get a report for you on the industry average. But who wants to be average, because everyone who is average has a cash-flow issue, you want to be the best or at least in the top 5% right. Between 6 and 8 is probably average for a lot of businesses, so getting it over 10 if you are currently 7 could make a huge difference to you.

• ii) the Number of Inventory Days

= 365 / Inventory Turnover Rate
eg = 365 / 6.08
     = 60 Days

The Purpose; is to measure the efficiency of inventory or how many times during the year your company is able to sell a quantity of goods equal to its average inventory.

Case Study; you see, I remember speaking with a service business a number of years ago with a cashflow challenge. They had $50,000 in stock on the shelves on the retail side of things, they were trying to compete with a specialist retailer in the area who had approx $50-60,000 in stock. They knew that the specialist retailer had sales between $500,000 and $1m and the service business owners had dreams of making the retail side of the service based business hit those kind of numbers. The challenge was that they were only at about $150,000 in sales. The specialist was accurately stocked, the service business was way way way over stocked. Either they needed to increase sales by about 5 times as much or reduce the stock levels to about $10,000.

Step 2) Understand there are only two ways to improve these numbers;

• i) Reduce Stock Level (or)

• ii) Increase Sales while maintaining the same stock level (basically just Sell More)

Step 3) Take action with one or more of these methods;

• i) Don't by massive bulk for discounts; You might make more margin, but if you buy an item, which you sell 1 per month, in a quantity of 100 you're an idiot! However, you can do this if you have a larger amount of working capital, but if you are reading this article cash-flow is your challenge, so you need to know the individual item turnover rate, educate your team and make better decisions.

• ii) Take Stock on Consignment; Talk with your current supplier, or tender to other suppliers sighting the need for consignment terms.

• iii) Be a Distributor without Inventory; Think Amazon.com. They are a big online retailer who has managed to have 0 days receivables (gets credit card payments upfront before it places an order for people), and has a very minimum of inventory amounting to approx 23 days. In other words they stock inventory of fast moving items but are in effect distributors for most other items. What ways of promoting your stock would help with this? Sales brochures, websites, catalogues, etc, all methods where you don't need the item on a shelf to sell out of the importer or manufacturers office.

• iv) Return Surplus Stock; If you identify excess items, check your terms with your supplier, you may be able to return them or at least get a credit.

• v) Just-In-Time System; Here's one for the University educated types, the text book ‘just-in-time' system. It basically says, replace the stock just before you need it and the closer the better. Go from months to weeks or from weeks to days or days to hours and you'll make improvements to your cash-flow. Go too far and you'll run out of stock and not be able to make a sale if asked. So set up minimum and maximum stock levels and use accounting programs or retail Point of Sale/ inventory systems to setup and have reminders and triggers and even automatic ordering or daily /weekly reporting to make this easy and deliver results!

• vi) Promotion - Sell a slow moving item with a fast moving item; Clear Stock items that move slowly or not at all by discounting them and pairing them with a best seller or regular item and don't replace it. "Buy Product A and get Product B at cost"

i.e. you figure out you have 20 of product B and they cost you $12 each (because you got a good deal by buying them in bulk, right? I mean they cost $18 if brought separately so this way you can make more profit margin, right? WRONG! Not if you can't sell them you are just wasting your cash and the ability to make money from the available cash you have). Let's assume a normal sale price of $25 on this product. Through your investigations you find you have only sold 2 in the last year, and 2 in the year before that. So it doesn't take a rocket scientist to see that you have 10 years worth of product sitting there.

What you are basically doing here is saying I'll invest $240 ($12 x 20) and for that investment I will receive a payment of $50pa for the next 10 years for a totally return of $500. That's no better than putting the money in the bank at 10%pa, in fact it's worse because in a business you have all the expenses to pay and the physical effort, strain, stress and brain damage to get the results.

If you are in retail you should have an accurate record of stock and you can then calculate individual stock turn rates (inventory turnover rates). Find a fast item and sell off the slowest item with it in a pairing, with the slow item priced at cost or similar. You are much better to get your ‘capital' (money) out of that ‘investment' (slow item of stock) and put it in another ‘investment' (fast moving item of stock) to get a better rate of return!

Conclusion: Increase your Inventory Turnover. The faster you can move inventory, the less cash you will need.

The dirt on WIP

• 1) Payment Terms; The goal is to get payment faster, to do this we need to;
• i) get bigger deposits,
• ii) get deposits at sale time not at job start time,
• iii) invoice as fast as possible, that means completing the jobs as fast as possible and invoicing immediately, and for larger jobs agreed regular progress payments, weekly or at set stages of completion.

• 2) Ideal Schedule; For common type jobs set a ideal schedule to run to... placing the number of hours to complete a standard job along a timeline. Understand and list what events that can hold things up (possibly other suppliers) or stall progress while waiting for decisions (from the customer may be). Now set about designing this process to ensure things don't get delayed, ask yourself this question, "In an ideal world how fast would we do this job?" and follow up with "what is stopping me do this now?" and finally "what can I do to prevent this delay?". Challenge the status quo and look to capture information before it is needed. You need to set up things and confirm things so there are no delays. Doing this could get jobs completed in 2 weeks rather than perhaps an average 4 weeks, reducing your cash gap by up to 14 days!!

• 3) Cost Components; Know the different components that make up the direct cost of your service work or production/manufacturing work. Also know when you pay for them and compare that to when you get payments from the customer. Notice any issues? What can you do to resolve each issue?

• i) Labour; it's likely you pay wages weekly for 40 hours upfront. Are you getting a good margin on each of those billable hours or production hours? Do you measure that? Is there a delay in when you pay the team for specific work and when you receive payment for that specific work?

• ii) Parts or Stock; the issues from the above section on Inventory relate here to.

• iii) Raw Materials; look at the levels and specifications for raw materials you have set in your business, when was the last time this was checked for accuracy. Als look to minimise waste. Do you produce a high number of one type of finished good in a production run? Are you producing too much of that item at once so it sits on the shelf for months and months? There is a point where cost savings from bulk production hits your cash-flow.

This week's Action Points...

Take one thing away from this article. Get Urgent!

Improve Cash Flow - How To Decrease Your Receivables Period

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• Increase payables period
• Decrease collection period
• Increase inventory turnover/Decrease WIP period

This week we take a look at the second area; Decreasing Your Account Receivables' Collection Period. Here we are aiming to speed up payments from your customers and get them to stop using you like a bank. I know this is of interest to you, check out these practical and easy to implement strategies.

The Cash Gap Clarified

If you still need clarification on the Concept of the Cash Gap, here's the visual aid below again and a link to the explanation article understanding cash flow from 2 weeks ago.

Overview

If you have large debtors or accounts receivable levels then this is basically your customers using you as a bank... do you look like a banker? ... but, you probably don't enforce late payment penalties like the bank or charge interest... that's free money for your customers... if you also have an over draft you're paying their interest! STOP IT, collect that money in!

Think about how you have the whole Receivables area of your business setup.... do everything in your power to; i) reduce the % of sales that go into accounts receivable to begin with, ii) reduce the terms you give, iii) prevent it becoming overdue, iv) collect it in fast once overdue.

Here's some top shelf tips to nail this area in your business once and for all...

You have three key areas and times to consider, to ensure successful Accounts Receivable Management;

• 1) Before: Setting your Terms
• 2) During: Communicating with the Client
• 3) After: Post due date Credit Control activities

Will you be able to do all of the following strategies in your business?....YES. You thought I'd say ‘no' didn't you. The fact is how YOU CHOOSE to run ‘your business' is up to you. It's not set by your competitors or your industry or your customers... if it's all doom and gloom providing a particular service, then you can choose not to provide it and provide something else that you can have more favourable outcome. Take note;

1)   Create more favourable Terms:

1. Reduce Credit Terms: Give 15 day terms instead of 30 days. Or 7, 14, or 21 day terms not 20^th of the month following which is 20-50 days. Ok, ok, ok... yes different industries have certain set terms of trade commonly the worst is 20^th of the month following, and in all likelihood if YOU CHOOSE TO WANT accounts over a certain size then yes you will need to offer the industry standard. However, what about everyone else.... don't offer the standard 20^th of the month terms to everyone, even if these smaller customers only make up 10% of your total revenue if you reduced the average days in Accounts Receivable from 50 days to 0 for that 10%, that could improve your overall A/R period by 5 days. Categorise your customers and prospects and write definitions & rules of each group and the different terms;

a) Group A 20^th Month FollowingRules
b) Group B 7 Day InvoiceRules
c) Group C On DeliveryRules
d) Group D In AdvanceRules

People that are not on account with you when they call your company to place an order, ask them upfront "How would you like to pay for that c/card or cheque or cash?" If it's c/card take the details over the phone at order time and charge the same day the service is completed, or product is sent.

Doing regular work with any clients? Setup a monthly in advance fixed price agreement with them. They can benefit from a lower rate and the certainty of a fixed amount each month and you can benefit from cash BEFORE you do the work. This is the future for many successful businesses, sort out a programme or package product or service and you'll have cash in the bank to make bold decisions with.

1. Deposits: Many businesses take deposits for work to be done, why don't you? If you do already take deposits currently why not change the amount. I've worked with businesses from Kitchen Designers to Painters, who typically would take 25% deposits at the start of a new job/project. I asked why don't we ask for more, why not 50%? What about 60%? The reaction... "you can't do that!" why not? "well, no one else does, and the customer won't buy that"... mmmm... maybe not 60%, but everyone else in your industry has a huge cash gap, and we aren't going to accept that, let's start at 40%!

Think about it! This could increase the cash in your bank account dramatically. I've seen clients go from getting a 25% deposit of an average job of $12,000 which is $3000, to getting 55% upfront that's $6600 with no decrease in sales!

1. Discount for early payment: Power and gas companies have this down pat. "Pay before the 14^th and receive a 5% discount, after that date pay the full amount". Of course extra margin is built in, so you could introduce a 10% price increase in your business for the start of the next month (it's inflation city out there right now, so you need to do this to make the same profit anyway, right! Can you afford not to?), sweeten the deal and soften the impact by offering a 5% discount, or even 10% if you like because cash flow improvement is what we are after, but only if they pay by the 10^th of the month, not the 20^th.

1. Instant Late payment Fee: Much more effective than the standard flat interest rate charge per day on accounts of late payment. As in many businesses the interest rate term for late payment may as well not be there at all. It can be a hassle to figure out, to monitor or too scary to attempt to enforce. An instant late payment fee can be much easier and has the power of being very visual on invoices or statements as an extra cost. Banks, finance companies, telecommunications companies understand this, i.e. unarranged OD fee $25, late payment fee $25. People will be way more inclined to keep to the terms to avoid penalty.
   
   
2. Terms & Conditions Document: Get a standard document or better yet a tailored document from a business lawyer, to reflect your business, industry, concerns and risks. Get all clients, customers, jobs, and projects to sign and agree to before you commence work. For existing customers, get them to sign an updated document or agreement. Make as few exceptions as possible... only payment in advance is likely to not need this, even then have a terms and conditions document clearly displayed at your place of work and website.
   
   
3. Collection Costs Clause: Unfortunately every now and again most businesses will have a customer which can't or refuses to pay, and the costs to enforce collection through a 3^rd party can be prohibitive and question whether it is even worth the cost and risk and hassle to collect... giving business owners the hard choice of writing off the invoice/s as bad debt. With a collection cost clause making the client liable for any and all collection costs you can be save to purse in many cases.

1. Factoring vs Overdraft: For a growing business they need a growing working capital amount. Perhaps you started with a $50,000 overdraft and that has been long since spent and now you are growing strongly and starting to make good profits but you never see any of the cash and you are finding you are short of cash... well the business probably needs more capital investment. For some B2B businesses factoring can be a better alternative than an increase in the overdraft. You'll probably be best to have $1m + in revenue and have 60% or more business account customers to be attractive to the factoring companies. It can mean 90% cash on invoice to your business, so definitely worth investigating.
   
   
2. New Accounts:  Do a credit check with Dun & Bradstreet or Baycorp or whoever or ask for non related party references.

2)   Keeping the Communication Immediate & Frequent

1. Invoicing: Do it immediately, don't wait until the 3^rd of each month to send the invoices all in one go for the last month. Change your internal processes if you find this difficult. Don't be a dinosaur, doing business requires improvements or you'll suffer the consequences, no cash! Invoicing is a priority, if you've done the work get payment for it! With accounting packages you can set them up to print automatically once an invoice is created for daily posting/faxing or even send an eMail automatically saving; hours of administration, money in postage, trees in paper, and the customer gets the invoice faster than any other method! Don't have the eMail address... ask for it!
2. The Invoice: Don't have the words or category boxes "Current, 30 days, 60 days, 90 days+" on the page, it screams "it's ok to pay us 90 days+, other people do, look we'll even keep you informed and update each month on your journey from current to 90days+ by displaying that progress in the next box". An account is either Current or Overdue, that's it! Additional to this you can have colour stamps or hand write or use a highlighter to bring stand out attention to the due date.
3. Monthly or Weekly Statements: Send statements separately than invoices with an included copy of your terms and conditions. You could always send weekly if you have many invoices, and make it persuasive for the client by sending any statements with overdue amounts on light red coloured paper to express urgency.
4. Delivery methods:

•  
  • Email; use the "High Importance red "!" to flag the eMail.
  • Post; use "urgent & confidential" stamps on envelopes.
  • Fax; use covering letter or fax header sheet highlighting due date and terms.

3)   Implement A Credit Control System

1. Flowchart the Process: This has got to be one of your best strategies. Create a step by step flowchart of what happens when an account or invoice is not received by the due date. i.e. Day 1 eMail, Day 2 Phone Call, Day 3 Fax Letter, Day 4 Ph Call, Day 5 Post Letter ...etc... At each step of the way you should have a standard script for calls, template for letters, faxes and eMails...and a clear desired outcome from each step. Do this from Day 1 through to Day 30, then it should be referred to a 3^rd party Debt Collector.

With a clear process you will start the communication early not wait until the 1^st of the month to start collecting 20^th of the month accounts, HELLO... that is 10 days overdue before you even start doing anything!!

2. Follow the System: There's no point having one if you don't use it.

3. Make Arrangements: It is much better to get a client early on making a regular weekly commitment to paying an overdue account off than to wait until they pay the amount in one hit... that day may never come or it might take three times as long.

4. Outsourcing: Hey, I understand collecting debt is not too fun. So why not outsource it to a professional. The major benefit here is that you and your team are left to focus on the really important things like marketing and sales and making strategic decisions to move the business forward, and you don't get bogged down, lose focus, become bitter and twisted with the world by a warped perception of people, customers, business and your opportunities.

Add to that, if you're kind of avoiding the area of collections right until it's so painful that you have to do something about it, then having a professional to do this for you will likely start to save you in interest charges with the extra funds in the bank.

5. Debt Collection: Credit Control is not Debt Collection. Debt collection is the next step from credit control, it is what happens once you or your outsource credit control company fail to get paid by your businesses pre-determined number of overdue days. Some businesses it is as short as 30 days, some 60 days others just don't have it. I'd recommend between 30 days no contribution toward the account.

This week's Action Points...

This area doesn't take a rocket scientist to figure out, but what it does that is a little organisation and commitment. Make the rules, then follow the rules.

Improve Cash Flow - How To Increase Your Payables Period

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• Increase payables period
• Decrease collection period
• Increase inventory turnover/Decrease WIP period

This week we take a look at the first area; Increasing the Average Days in Payables. Basically this is slowing the Outflow of cash from your bank account. If this interests you, check out these practical and easy to implement strategies.

The Cash Gap Explained

Remember our visual aid from last week's mimosaWEEKLY TIP^TM? Take another look...

If you didn't see that article or if you feel you need a bit of a recap, follow this link to understanding cash flow. What we are aiming to do this week is come up with a few quality ways to increase your payables period. By doing a few key things we might get it from 30 days to 40 days in the above example. In some businesses this could be the difference between healthy growth and financial pain, and for some businesses owners it could mean a good night's sleep.  

Let's cut straight to the good stuff...

Disclaimer: Don't be a pessimist!!! When reading each of these strategies below you may find yourself tempted to scoff and say "I tried that" or "you can't do that" or "yeah, it might get another day or two but what difference is that going to make", stop yourself and think "this strategy may only get an extra 2 or 3 days but if I do lots of little improvements I'll end up with a noticeable and possible 10 day difference in payables. Now, add to this a 10 day improvement in each the other two areas of Inventory/WIP and Receivables and I could improve the 90 day cash gap to 60 days! Now, that's not something to scoff at!".

I realise that in most businesses, especially small businesses, the payment terms are largely set by tradition and much bigger suppliers. I totally get that, however there are a number of ways to improve things where you can, not all suppliers will change, but some you can make improvements with. Good Luck...

1) Negotiate Longer Terms with current Suppliers.

You can do this in a few ways.

a) Tender each account you have, from core suppliers of products you sell or raw materials you use to manufacture, right down to insurance and phone companies. Not only in many cases will you get a cheaper rate than you are currently on, but you can let more flexible suppliers know that you are willing to pay a higher price (higher than the new tender price, which is quiet likely lower than current suppliers) for longer payment terms, i.e. if your current supplier has a unit cost of $9 and payment terms of 30 days, you go out to tender and then negotiate to a new unit price of $8.25 with the current supplier or a new supplier, you can then say to that supplier "what is really important to me is longer payment terms to make sure we sell the product, so what about we pay $9 but have 20^th of the month following terms?" With careful purchasing this can yield up to an extra 20 days.

Go through every single expense you have, I remember saving 50% on my annual insurance bill alone and increasing the payment period to monthly from yearly. I've now got the whole year to pay for it and even with the interest added on for monthly vs yearly payments was still 40% cheaper! And the policy was more comprehensive! Is this an extreme example, yeah, but follow this thinking and you can get some good increases in terms.

b) All the places that you don't have an account, set one up, or always purchase those products from a supplier you do have an account with. Think of all those client, prospect, or networking partner coffees you have, if you have a regular place or two, talk to the owner and set up an account... it's in their interest to, which place are you more likely to recommend your meeting is at, the place where you have an account or another place down the road?!?!. Not the latte type, just keep looking through your expenses, you'll get a few interesting ideas.

2) Don't pay earlier than you need to.

Sounds obvious right, but sometimes the practical execution of this is not always the way, as many businesses pay all accounts on a given day of the month. This may be easier from an admin perspective, but there could potentially be a few days to unlock from setting up a gradually payment process that pays accounts on due date and not before. The truth is in this area many of you may already be robbing suppliers here by doing the reverse, i.e. not paying any accounts, regardless of the 20^th of the month terms or 14 day terms, until the 28^th of each month. Careful, people have long memories and you'll find yourself in no position to take advantage of an excellent supplier relationship, if the opportunity should rise.

3) Implement a Purchase Order System.

This really is designed to make you and your team think about purchases before just spending money without thought. You can write rules that give people the power to spend up to x amount for a, b, & c reasons, and anything else needs to be approved by you or an intermediately team member.

4) Use a Credit Card.

Warning, warning, ("Danger Will Robinson"), if you are; 1) not making profit, 2) are not likely to make profit in the next few months, 3) can't be trusted with a credit Card.... then stop reading this strategy, it is not for you, because if you misuse this, you can simple increase debt and reduce profit, and add to your financial woes not improve them.

However, do this correctly and whatever accounts you can pay with a Credit Card you can get an additional 25-55 days credit!!!! Wow, plus get all the frequent flyers points or reward from all the expenses paid through a credit card. Which enables you to buy personal expenses that you would otherwise need cash for, so it can increase your personal disposable income. Let's look at an example.

Take a mobile phone bill, let's say the account runs on a calendar month and is due on the 15^th day of the next month. Now let's look a credit card also setup on a calendar month, so just to clarify... goods or services purchased on the 1^st of the month get 55 days free credit as the payment is due about the 25^th of the next month, items purchased on the 30^th get 25 days, make sense? Now, in the mobile phone bill example, we would get 40 days (15+25) total credit, an extra free 25 days credit on top of the 15 day terms from the mobile service provider, awesome! Find out who takes Credit Card, ask them if not why not, ask them have they thought about setting it up, these days suppliers can have a web portal to do it online, manually or automatically, no machine needed, just a merchant account.

This Weeks Action Points...

Print out the last 1-12 months of expenses and run through each, delegate some to people in your team. Ask current suppliers for new terms, ask alternate suppliers for a proposal for your business, set the wheels in motion now, because next week we'll have a list of Accounts Receivable Management Strategies and you'll want to have started making a change with Payables first!

Understanding Cash Flow - The Cash Gap

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Understand It To Shorten It

The cash gap affects nearly every company, causing financial pain and disbelief amount many business owners. So why is it that when it is explained to people the explanation most often lacks any visual aids and logical examples that simplify the concept so you can fully understand it easily?

If I miss nailing making this explanation clear, tell me, because this is really important and as soon as you fully understand the simplicity of it and the impact it has on your business, you can go to work on reducing it, giving you more money in your bank account and a good night's sleep.

There are only three ways you can reduce your cash gap, do you want to know what they are?

The Cash Gap Explained

Take the four different Bars on the time-line below; 1) You buy inventory at day 0, lets say that inventory sits on the shelve for 60 days as shown until you make a sale. 2) The inventory you purchased was on terms of 30 days. 3) You sold the inventory on the 60^th day it was in stock as mentioned earlier and you give the customer, let's say 30 day terms, but they pay late by another 20 days, pushing the total Accounts Receivables period to 50 days. 4) The fourth bar in red represents your cash gap, it is the difference in days between when you paid cash and received cash, in this case 110 days minus 30 days, which is 80 days.

So what does this mean?

Well, the 80 day Cash Gap from the above example has to be funded somehow. Most business owners end up with a bank overdraft at some point to fund this gap in cash. Others have working capital or shareholders funds or shareholder loans in the business, which are either funds introduced by the business owner at start up or perhaps a re-mortgaging of the family home to inject some funds in... one, two, ten, or twenty years down the track (at anytime).

For the profitable business, that is not growing too fast (yes it is possible that growing too fast without funding for working capital can lead to bankruptcy), they can increase the equity/working capital/funds in the business by retaining profits in the business. The more of a war chest of money the business builds up the faster the business can safely grow without getting caught short.

So, what we are saying here is that whatever the cash gap is, it will need to be funded somehow. And we all know that funding costs money in the form of interest, right? Let's look at that cost...

Example 1: abc company ltd
Inventory 60 days
Payables 30 Days
Receivables 50 Days
Cash Gap (60+50)-30 = 80 Days
Annual Sales $1,000,000
Daily Sales = $1m/365 = $2740
Gross Profit Margin 35%
Cost Of Sales = 1 - 35% = 65%
Daily Finance Required = $2740 x 65% = $1781
Interest Rate 10%
Daily Interest Cost $1781 x 10% = $178
Annual Interest Cost $178 x 80 = $14,240
Working Capital Required ($1781 x 80 = $142,480)

Let's say ‘abc company ltd' understood this impact and cost on the business and focused on tactics to reduce the cash gap by 30 days to 50 days...let's look at the difference and financial benefit to the business...

Example 2: abc company ltd (reduction of cash gap from 80 days to 50 days)
Annual Interest Cost $178 x 50 = $8,900
Annual increase in Net Profit = $5340.... ($14,240 - $8,900) what would you do with an extra $5k NP? Pay yourself more, pay off creditors, retain in the business...
New Working Capital Figure Required ($1781 x 50 = $89,050) Wow, a massive extra $53,430 ($142,480 - $89,050) reducing the overdraft, or getting that shareholders loan back.

What is the impact on my business when I grow with a cash gap?

Let's take the above example a little further...let's say that ‘abc company ltd' grew revenue by 40%, but didn't focus any attention on reducing the cash gap so it remained at 80 days.

Example 3: abc company ltd (40% revenue growth with no change in cash gap)
Annual Sales $1,400,000
Daily Sales = $1m/365 = $3836
Gross Profit Margin 35%
Cost Of Sales = 1 - 35% = 65%
Daily Finance Required = $3836 x 65% = $2493
Interest Rate 10%
Daily Interest Cost $2493 x 10% = $249
Annual Interest Cost $249 x 80 = $19,920
Working Capital Required ($2493 x 80 = $199,440)

The problem just grows! Now we need an extra $57,000 in capital to operate this business at this level ($199,440 - $142,480). The key scary element here is the fact that as a business grows the working capital required to operate the business at the new level also grows. You see, if you are like most business owners you probably started the business with a certain amount of funds to invest, let's say it was $40,000. Now, that money soon gets spent, and money owed to suppliers starts to mount, the business might run at a loss for 6mths or a 1yr until it starts to make profit. The challenge is as the business grows and begins to make a profit, these profits need to pay off the mounted supplier debt, but because of the cash gap most business owners soon run out of cash to make the whole thing work, they need more working capital. So, what happens, they go to the bank and get an overdraft or loan, let's say for $50,000. This works, they can then pay themselves some salary, pay back some suppliers and focus on growing the business again.... until... it grows to a point where the $90,000 is just not enough funds and they run out of cash again, and even start going backwards cash wise.

This is where disbelief and confusion sink in, "but I'm making profit and paying tax... what the heck!?!?!?!?!" I mean, now the business is paying $5,000 a year just in interest charges, for what, to stay open? The tempting thing to do is go back to the bank and borrow more. Hey it worked last time, right? I'm all for using financial leverage, but first of all tidy up your cash gap, it's a lot more profitable!

Let's look at the financial impact of ‘abc company ltd' also focusing on reducing the cash gap has...

Example 4: abc company ltd (40% revenue growth and reduction in cash gap by 30 days)
Annual Interest Cost $249 x 50 = $12,450
New Working Capital Figure Required ($2493 x 50 = $124,650)

If we look at Example 1 the Working Capital Required was ($1781 x 80 = $142,480) and in example 4 it is ($2493 x 50 = $124,650). Think about this for a second, what has actually happened is that even with the huge 40% growth in revenue ‘abc company ltd' needs less working capital to operate because they focused on the powerful tactics to reduce the cash gap. What does this mean? ... they would need to borrow any more money.

There are only three ways to reduce the cash gap....

• Increase payables period
• Decrease collection period
• Increase inventory turnover

The next 3 articles in this series on The Cash Gap will focus on tactics to execute in each area. Some industries have much larger cash gaps than others, so they require more working capital. Some businesses don't have stock they have work in progress (WIP), most retail businesses don't have a long collection period but have long inventory periods, service business have little if any inventory period so the quality of accounts receivables management really determines the cash gap.

Whatever the situation, industry, and type of business you have, one thing remains the same, if you remain ignorant to the cash gap, you'll never control it.

Beware when calculating your own figures. Most businesses I have seen over the years do not accurately account for all true ‘Costs of Sales' and therefore have a much larger gross profit margin than is actually the case, seeing a 60% Gross Profit Margin % (GPM%) drop to 30% is not uncommon once this is corrected. A common error is non-administrative type wages in expenses not in Cost of Sales. This is important because a lower GPM% than is correct will affect the financial figure in your calculations and give you a much rosier picture of funds required than is true.

You may be wondering; "How do I find out what my inventory days, receivable days, payables days figures are?"

These are all standard and simple financial calculations, if you know the formula, all you need to do is take your financial data at the end of each month and you can calculate...

This Weeks Action Points...

Run your own numbers, do some rough ones yourself or better yet ask your accountant to do accurate figures, heck... there is some kick-ass software out there called "Profit Optimiser", if your accountant doesn't have it or its equivalent, call me.... you need a new accountant cause you have a ‘tax return filer' and I know plenty that do have ‘profit optimiser' and can show you the financial impacts from focusing on reducing your cash gap. Very Powerful.