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4 Steps to Improve Your Cash Flow Cycle

May 1, 2014


Cash flow is often called the "lifeblood" of a business, and for good reason: Without strong cash flow, even companies with solid sales and profits (at least on paper) can run out of money and go under. In fact, poor cash flow is the cause of more business failures than lagging sales or a lack of profits. Companies can often ride out short-term periods of unprofitability - but not a lack of cash.

The first step in strengthening your company’s cash flow is to carefully examine your cash flow cycle. This describes how cash moves into and out of your business. For most companies, there is a time lag (often significant) between when money goes out to pay for business expenses and when it comes back in via collected accounts receivable.

A Typical Cash Flow Cycle

In the typical manufacturer’s cash flow cycle, cash goes out of the business to buy raw materials and inventory and pay overhead expenses like salaries, insurance, rent and utilities. Products are then manufactured, warehoused and then sold. Customers are invoiced and usually given payment terms, ranging from 15 to 60 days or longer. Cash doesn’t come back into the business until the accounts receivable are collected and deposited.

When you understand these components of the cash flow cycle, you start to see how easy it can be for a business to run out of operating cash even if its sales and profits are robust. This is especially true for new startup businesses and businesses that are experiencing rapid growth.

One solution to this cash flow challenge is to borrow money from a bank or finance company to help carry you through the cash flow cycle. A line of credit is most commonly used for this purpose - it enables businesses to borrow up to a pre-determined amount of money without having to re-apply whenever they need cash. Working capital loans and business credit cards can also be used, though credit card financing can be expensive and generally shouldn’t be viewed as a long-term solution.

Factoring and asset-based loans are another type of financing that can be helpful here. These are an advance of funds to your business against outstanding accounts receivable. A commercial finance company will purchase your eligible receivables and advance you a percentage of their value. You will receive the balance, less the factoring fee, after the receivables have been collected. Factoring tends to be more expensive than bank financing, but it can be a lifesaver for companies that don’t qualify for a traditional bank loan.

Related Article: 6 Tips to Re-Energize Your Company's Cash Flow

Improving Cash Flow Management

If you prefer not to seek financing to help carry you through the cash flow cycle, or if your business doesn’t qualify, then your best option is to shorten your cycle and improve cash flow management. Here are a few suggestions:

  1. Reduce your investment in accounts receivable. This starts with tracking your outstanding receivables by generating a monthly receivables aging report. This report will tell you at a glance which accounts are past due and how late the payments are — for example, 15, 30 or 45 days past due.

    While you might have to offer payment terms in order to remain competitive, negotiate with your customers to shorten them as much as possible. Also consider offering prompt-payment discounts — for example, offering a 2 percent discount on the invoice if payment is made in 10 days, instead of the customary 30.

  2. Revamp your payables processes. This is the flip side of the equation: You want to extend your accounts payable as far as possible while still honoring the terms negotiated with your vendors and suppliers. If your payment terms are net-30 days, for example, set up your accounting system so that the invoice is paid on day 30 — and not a day sooner or later. If possible, renegotiate with your suppliers to obtain the most generous payment terms they’ll offer you.
  3. Manage your inventory more efficiently. Implement Just-In-Time (JIT) inventory management practices so that raw materials are delivered to your facility just when you need them, instead of weeks early. Doing so will shave days of inventory carrying expense off your cash flow cycle and save money in storage costs.
  4. Talk to your bank about cash management services. Banks offer a variety of cash management tools that help small businesses increase their cash flow. Wholesale lockbox, remote deposit capture (RDC) and Automated Clearing House (ACH) for a variety of electronic payments, for example, could help you process receipts faster and speed up collection and deposit of your accounts receivable.

    Lockbox and RDC can be especially helpful for many small businesses dealing with cash flow challenges. These services can shave precious days off the cash flow cycle by getting checks deposited immediately, instead of whenever an employee gets around to driving to the bank to deposit them.

To discuss cash flow management strategies or business financing in more detail, give us a call at (800) 773-7100 or Contact us and request that a Relationship Manager contact you.

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