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
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
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.
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:
- 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.
- 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.
- 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.
- Talk to your bank about cash management services. Banks offer a
variety of cash management tools that help small businesses increase their cash
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.
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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