Unplug the Money Valves

Your company’s ability to manage cash flow is critical to its survival. Enterprises that successfully practice good cash management generally survive and prosper. Those that don’t are likely to be undone by the weight of increasing debt — if it’s even available — and the inability to pay employees and suppliers.

Maintaining smooth cash flow requires juggling most aspects of your enterprise, from accounts receivables to extending lines of credit and managing inventory. Increasing cash flow reduces the amount of fixed capital required to support your ongoing operations.

It may help to think of the process in terms of the cash cycle, which is the amount of cash your company needs in terms of days of activity to keep operating. Let’s assume your business had the following financial statistics at the end of its most recent fiscal year:

Annual sales	$3,600,000
Annual cost of sales	$3,285,000
Billed accounts receivables	$   600,000
Unbilled accounts receivables	$   400,000
Accounts payable and accrued expenses	$   450,000

The first step in calculating the cash cycle is to determine the amount of average daily sales and the cost of sales. Dividing sales and cost of sales by 365 days gives you average daily sales of nearly $10,000 and average daily cost of sales of $9,000.

Then you calculate the number of days’ investment in billed and unbilled accounts receivable:

Billed accounts receivables	$   600,000
Plus unbilled accounts receivables	$   400,000
Subtotal	$1,000,000
Divided by average daily sales	$     10,000
Number of days investment	100

Thus, it takes 100 days on average between production of a good or service and payment. Similarly, using the daily cost of sales average, you can determine the number of days financed by vendors and employees:

Accounts payable and accrued expenses	$   450,000
Divided by average daily cost of sales	$       9,000
Number of days financed	50

With that in mind, here are eight tips to strengthen your business’s cash cycle and increase cash flow:

1. Stretch out your payables. Take the maximum time to pay your suppliers. Essentially this amounts to an interest-free line of credit and gives you more time to use your working capital.

2. Take advantage of payment incentives. If your suppliers offer you a discount for paying early, take it. Refusing it can be a major mistake. Let’s say you owe $1,000, but you could reduce that to $980 by paying the bill in 10 days rather than the usual 45 days. Foregoing the discount costs your business $20 to hold on to your $980 for 35 days. That is like borrowing money at a 21.3% interest rate. If your suppliers don’t offer incentives, ask for them. Many will be willing in order to speed up their own receivables.

A healthy cash cycle requires some cash flow forecasting. This helps you plan your cash balance and know if you will need to borrow at certain times of the year and how much surplus cash you are likely to have at certain times. Your cash flow forecast is usually done for one year or a quarter in advance and divided into months or weeks. For companies  who are barely making ends meet to pay their day-to-day expenses, a daily cash flow forecast may be needed.

3. Organize your billing schedule. The faster your business collects receivables the more money it has to spend. Prepare invoices as soon as goods or services are delivered. Waiting until the end of the month may add as many as 30 extra days to your cash flow conversion period. Offer discounts for fast payments, and if your business provides a service, ask customers for a deposit before work begins.

4. Closely track and collect overdue accounts.Software can help your business automatically classify the age of accounts receivable and flag overdue accounts. Act immediately on past-due accounts and use a collection agency if necessary.

5. Use fund transfers. If you use electronic fund transfers in place of cheques you can reduce your collection cycle.

6. Split business between suppliers. Sometimes you want to buy equipment, say computer hardware, from a value added reseller who can help you choose the right system for your needs. Other times, however, consider buying routine materials such as cables, software, paper and printer cartridges from a mail order catalogue at commodity prices. Alternatively, get together with some colleagues to buy supplies in bulk.

7. Keep a lean inventory. Having too much stock can tie up large amounts of cash. Calculate your turnover ratio (cost of goods sold divided by the average value of inventory) to keep turnover within industry norms. Regularly check for old or outdated stock. You can defer future orders to get rid of that stock or sell it at cost, which would improve your company’s liquidity.

8. Consider leasing instead of buying. Leasing computer equipment, cars, tools and other gear costs more than buying, but you will avoid tying up cash. Lease payments are a business expense, so they will also help lower your taxable income.

Talk with your accountant or business advisor who can help you review your cash flow statements, find weaknesses and come up with solutions to maintain a healthy balance between cash flowing in and out of your enterprise.