How Do I Positively Impact Cash Flow?

When focusing on a small business, there are only a few levers a company can trigger to impact its cash flow: 

1. Collect Faster from Customers: Instead of extending credit to customers to 60 or 90 days, collect within 30 to 45 days. There is a simple formula – DAYS RECEIVABLES OUTSTANDING = (DAYS IN THE PERIOD) * (AVERAGE ACCOUNTS RECEIVABLE) /NET CREDIT SALES. Simply calculated, take the number of days in the month multiply by the month ending ACCOUNTS RECEIVABLES balance less the beginning ACCOUNTS RECEIVABLES balance from the month divided by the month's non-cash sales. The number will indicate how many days it's taking to collect owed cash from customers. Measure this number for 3-4 months back and look for trends. Couple this with a simple Accounts Receivable analysis – like looking to see which customers own what amount of money for how long – and you will quickly see which customers are above the DRO metric – try collecting from those first. 

1. Pay Vendors Slower: Imagine a business that is paying its vendors before collecting from its customers. This is set up for a cash crunch. Instead, look at how quickly vendors are paid and look for ways to extend it. The formula to calculate the average days it takes to pay a vendor can be calculated as follows: DAYS PAYABLE OUTSTANDING = (DAYS IN THE PERIOD) * (AVERAGE ACCOUNTS PAYABLES) / PURCHASES ON CREDIT. This is the exact opposite of the DRO calculation – take the number of days in the month multiply by the month ending ACCOUNTS PAYABLES balance less the beginning ACCOUNTS PAYABLES balance from the month divided by the non-cash purchases for the month. The number will indicate how many days it's taking to pay vendors. Repeat the same steps as above – measure the number over 3-4 months and you will see a trend of how long it takes for vendors to be paid. Take a simple Accounts Payable statement and look at how much vendors are paid and how many days after receiving the goods and you will see a trend emerge. Then see which vendors you can negotiate with to extend the terms. 

1. Hold Less Inventory: For those businesses that have inventory, what is the right amount to hold? Ideally, nothing and everything gets purchased, produced, and sold the same day. In the real world, product-based businesses hold inventory, but tying up cash in inventory can be a recipe for disaster. Therefore, look at how long it takes to sell through purchased inventory. To do this, calculate the Days Inventory Outstanding. DAYS INVENTORY OUTSTANDING = (DAYS IN THE PERIOD) * (AVERAGE INVENTORY HELD) / COST OF SALES. The idea is simple, how many days is the business holding on to inventory it purchased with cash before selling it to a customer for cash. This is a tricky number to manage because reducing the inventory held can mean production shortages, potentially stopping assembly lines, leading to impacts on delivery and customer satisfaction. 

Understanding the three inputs above is critical to understanding how cash flows through a business. It also helps determine the net-working capital – or the Valuation Teeter-Totter. The Net Working Capital can be a simple calculation of taking the Current Assets (Cash + ACCOUNTS RECEIVABLES + Inventory), less the Current Liabilities (ACCOUNTS PAYABLES + Lines of Credit + Credit Cards + Short Term Debts + Accrued Liabilities). The difference in these numbers is the Valuation Teeter-Totter – A positive number means the business can produce cash on its own and a negative number means it needs a cash injection.