April 2011 Business Improvement Tip
This is the sixth in a new series of Business Improvement Tips which will be published each month - the next will be published in May 2011 - if you are not currently on our mailing list then click <here>.
Around sixty previous improvement tips plus other appropriate or useful information are being added to an e-book which will soon be available to download - we will let you know when it is available.
The previous two month's tips.
The February 2011 <here> and March 2011<here> improvement tips covered gaining financial mastery of your business by creating an instrument panel for monitoring Cash Flow Forecast and Breakeven. This month I will cover the third instrument for your business instrument panel - Cash Gap, .
Add yet another instrument to your business instrument panel ...
Consider this ... do you really know at which point in time you get full return on the cash you paid out for goods, services, wages and salaries?
Cash Gap refers to the time interval between the date when a business pays out cash for the goods it buys plus the staff it employs, and the date it receives cash from its customers for the goods and services it provides.
A cash gap can happen for many reasons - bills or invoices are paid weeks before cash comes in from customers - working capital is needed to buy goods and materials to use and resell - to keep staff paid - to invest in new technology and other equipment to keep abreast of the competition.
Cash Gap Explained
Cash Gap is a concept that helps you understand and measure how business processes affect business cash flow and is expressed as the number of days between a business paying out cash for goods and services bought and receiving cash for goods and services sold.
Basic formula ...
Cash Gap = Inventory Days + Receivables Collection Days - Accounts Payable Days
The cash gap must be financed - the longer the cash gap the more cash reserves a business must find to fill the cash gap period - the shorter the cash gap period, the better the cash position of the business ...
So - managing and reducing cash gap is a major profit improvement strategy.
Take the four bars on the time-line above ... let's say ...
1. You buy and obtain Inventory at day 0, the inventory sits on the shelf for 60 days, and you sell the whole inventory at day 60.
2. The Payables for the inventory you purchased were on terms of 30 days from day 0.
3. You sell the inventory on day 60 and you give the customer 30 day terms, but they pay late by a further 20 days, pushing the total Receivables period to 50 days.
4. The resulting Cash Gap is the difference in days between when you paid cash out on day 30 and received cash in on day 110, which is 80 days.
So what does this mean to me?
The big problem is that the cash gap has to be funded - in the 80 days example above you paid out your cash at day 30 and got cash in on day 110 - so that cash is tied up and not available for you to use for at least 80 days - that cash is not available to buy new inventory, to pay staff, to fund marketing, to invest in your business and similar.
At worst, assuming your inventory sits unsold on the shelves, you would have an extremely long cash gap which you will need to fund for an undetermined period - this is typical of retail businesses.
At best you sell and get paid for your inventory on the same day that you pay for it when the cash gap would be 0 days; it could even be negative, which is a highly desirable position. I always maintain a negative cash gap in my own business by getting paid for my services in advance.
Ignoring or not fully understanding the significance of cash gap will eventually break your business.
Whatever the cash gap, whether it is 5 days or 500 days, a positive cash gap will always need to be funded - somehow.
Long cash gaps can cause a highly profitable business to fail. The longer the gap the more effect it will have on your cash flow. At some point many business owners will be forced to borrow or seek a bank overdraft to fund this gap in cash. Others may be forced to re-mortgage the family home in order find the funds to keep the business working. Others will keep cash tied up so as to be available to fund the gap when needed - this cash is not available for other uses.
Investing time in creating and then operating a systemised cash gap management process before cash gap becomes a problem will be time well spent. In most small to medium size businesses a simple but well defined documented procedure is all that would be required.
So ... having a Cash Gap meter to monitor the situation would be highly beneficial to any business.
Strategies to shorten Cash Gap ...
There are many ways to improve your cash flow situation. The main area for action is gaining control of your receivables by producing and operating documented procedures so ensuring that so you will not find yourself on the short end of cash in the future. Here are a few ideas .
1. Ensure that your Terms and Conditions have been formally accepted by your customers and suppliers - in particular ensure payment terms are fully agreed - this could minimise problems later.
2. Get on friendly terms with the person who pays your invoices - people tend to pay people they know and like - say "thank you" when you receive payment on time - send a small token "thank you" gift if they pay early.
3. Stand out from the crowd - send a bar of chocolate with your invoice - print invoices on coloured or other out of the ordinary paper - so that when you call them they will instantly recognise you.
4. Get to know your customer's payment system and determine how it fits with your own.
5. Monitor your customer's past payment history - grade your customers and act accordingly - run a simple debtors report each day or week, especially for low grade customers - set targets to reduce.
6. Systemise invoice and cash collection processes.
7. Invoice immediately on completion - ensure you have provided, as a minimum, exactly what you have agreed to provide - don't give your customers any reasons to delay payment.
8. Agree partial deposit or full payment to be paid up-front whenever possible.
9. Give discounts (1% to 5%) for early payment.
10. Add and collect interest on overdue accounts - ensure this is included in your agreed Terms and Conditions.
11. Outsource the entire invoicing process to speed up receivables - depending on your particular circumstances this could be cost effective.
12. Delay payment of your own invoices for as long as possible - although this is a way to hold on to your cash I personally am not in favour of the concept as it lacks congruence - you expect your customers to pay on time so you should pay on time - if your customers learn that you always pay late then they will feel that it is acceptable for them to pay late.
These are just a few of the ninety plus strategies I can provide to help improve your cashflow and shorten your cash gap.
Now is the time to make sure that you have working "Cashflow", "Break Even" and "Cash Gap" instruments fitted to your business instrument panel - and to make sure you use them constantly.
Remember that the success or failure of your business is your responsibility - not your accountant's, not your team's, not your supplier's, not your customer's, not anyone else's - just yours - so it really is in your interest to gain financial mastery in your business as soon as possible.
I would love to help you to build an instrument panel especially for you and your business.
You can't manage what you don't measure. Unless you measure something you don't know if it is getting better or worse. You can't manage for improvement if you don't measure to see what is getting better and what isn't.
If you think the price of success is high, wait until you see the cost of failure
Change for the better ... do it now.
Remember ... your business is neither a hobby nor a charity ... you run your business
primarily to make money (create wealth) for yourself and those you care about.
I can help ... no matter what product or service you may provide, what type of business you may have, what size of business you may have, how successful your business may be, how long you may have been established, or how slowly or rapidly you may want to, or need to, improve ... I can help you build a better business, a better lifestyle, a better life and a better future.
Call me now ...we will arrange either a free "no strings" Coaching Session - or a free "no strings" Business Health Check - where we will talk about you, your business, your challenges, your frustrations and your problems ... we will talk about your hopes, dreams, desires, aspirations and long term goals ... we will explore the opportunities for improvement which exist in you and your business ...
I will show you how you can achieve the business, the success, the lifestyle, the life and the future you really want and deserve to have ... or we could just have a chat, a cup of coffee, or tea, and a macaroon.
Call me now ... you have little to lose ... and a great deal to gain.
Jim Yates - 01778 345990
success@ardent-business-support.co.uk - www.ardent-business-support.co.uk |
