Understanding Your Cash Conversion Cycle

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For small businesses, cash flow is one of the most important determinants of business success.  There are many metrics used to monitor cash flow, one of which is the Cash Conversion Cycle (CCC). We coach all of our clients to track CCC as a key metric.

The CCC measures a company’s effectiveness at converting its investment in inventory into cash. The cycle typically involves purchasing inventory inputs on credit (Accounts Payable), selling the inventory through sales on credit (Accounts Receivable), and converting inventory back into cash. The lower the number of days in the CCC, the more effective management is at generating cash flow from the sale of its product or service.

How the Cash Conversion Cycle Is Calculated

The formula is comprised of three figures.
•    Number of “Days Inventory On Hand” (DIO)
•    Number of “Days Sales Ooutstanding” (see article on DSO here)
•    Number of “Days Payable Outstanding” (DPO)

The formula for calculating the Cash Conversion Cycle (CCC) is:

CCC = DIO + DSO – DPO

DIO, DSO and DPO represent the three component stages of the conversion cycle.  For a service company the cycle would only include the DSO and the DPO metrics.

Breaking It Down

Let’s look at each stage of the CCC to understand the relationships:

  1. The DIO stage measures the time (in days) required to turn over one complete inventory.  DIO can be calculated using figures taken from the annual financial statements; Inventory from the balance sheet and Cost of Sales from the income statement. It is calculated as:
    DIO = Inventory /Cost of Sales x 365
    The idea is to minimize the DIO by turning over inventory as quickly as possible. Selling inventory converts the owner’s investment in inventory into Accounts Receivable, or directly into Cash in the case of cash sales at a retail store.
  2. The DSO stage measures the number of days needed to collect the Accounts Receivable. Using the Accounts Receivable figure from the year-end balance sheet and the Net Credit Sales from the annual Income Statement, it is calculated as:
    DSO = Accounts Receivable/Net Credit Sales x 365
    Like DIO, a business owner wants to minimize DSO. DSO measures how quickly the business is able to convert a credit sale into cash.
  3. The DPO stage measures the number of days it takes to pay vendors for the inventory purchased or expenses incurred to deliver your product or services. Using the Accounts Payable figure from the year-end balance sheet and the Cost of Sales from the Annual Income statement, it is calculated as:
    DPO = Accounts Payable/Cost of Sales x 365
    In contrast to the DIO and DSO stages, business owners want to maximize DPO. A business improves its cash position by holding onto cash longer. Cash flow benefits, of course, must be carefully measured against a company’s payment terms with vendors.  Its important to maintain good relationships with your vendors because they help you grow your business.

The Cash Conversion Cycle metric is most useful in comparing a company’s cash flow performance this year against the performance in previous years, or against competitors’ performance.   By monitoring the trends of the CCC metric, you can spot potential cash flow issues before they become a crisis.

Numbers Coach Identifies Opportunities for Improved Cash Flow for Environmental Engineers

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THE COMPANY

In 1996, Scott Pate launched Sierra Piedmont (“SPI”) with a vision to create a superior environmental consulting, site assessment, compliance, and remediation services firm. Since then, SPI has served a wide range of companies from Fortune 100 businesses to regional firms throughout the United States. SPI’s innovative solutions and advice have helped its clients solve their environmental issues.

SITUATION

Pate and SPI’s management team wanted to realize improved cash flow in their day-to-day operations. However, they were not clear on which financial metrics were truly driving the business and needed more meaningful insights beyond the Profit & Loss statement.

SOLUTION: The Numbers Navigator™

SPI hired the Numbers Coach to provide a comprehensive analysis of its financial operations.The Numbers Coach (“NC”) uses its proprietary Numbers Navigator™ tool set to determine the key financial drivers in SPI’s business model. NC gained a further understanding of SPI’s key business issues through a discovery session with management. NC provided Pate and his team with a comprehensive financial report that identified opportunities to drive more cash flow from the business.

RESULTS

Together, NC and SPI determined realistic and actionable strategies to realize improved cash flow quickly. To achieve this goal, NC provided:

  • A 20+ page financial report detailing key drivers in SPI’s business model,
  • A systematic cash flow forecasting model to provide SPI visibility into its future cash flow,
  • “What if” scenarios analyzed to understand the impact of different financial strategies,
  • Establish guiding principles for disciplined cash flow management process
  • A short-term planning tool to ensure resources and cash were allocated appropriately

“Although it sounds cliché, Numbers Coach and the Numbers Navigator™ truly changed our financial life!” explains Pate.  “The fact is, for many years we had little or no ability to perform high level “what-ifs” or projections of cash effects based on pulling different levers in the company.”

“I don’t know of another program quite like this one,” says Pate. “It doesn’t seem boilerplate or ‘canned.’  I think the most benefit is received by using the Navigator in conjunction with Numbers Coaching services to understand how to apply what is revealed by the report to our financial metrics.”

To learn more about Sierra Piedmont, visit www.sierrapiedmont.com

To learn more about the Numbers Coach financial leadership services, click here

Head off Financial Stress with a 90-Day Cash Flow Forecast

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Short-term cash flow challenges are very common among small businesses. When a business responds poorly to a cash flow challenge, its ability to continue operations may be jeopardized. Unfortunately, a poor reaction to a cash flow challenge is what often happens.

A common approach is for a business with tight cash flow to monitor its cash balance daily and estimate accounts receivable for the next several weeks. The problem with that approach is that it doesn’t help you as the owner prepare for a cash crunch due to hit four to twelve weeks in the future. That’s why we recommend clients use a 90-day cash flow forecast.

Rolling 90-Day Forecast

The surest way to avoid an unpleasant cash flow surprise is to use a 90-day rolling cash flow forecast. The forecast usually takes the form of an Excel spreadsheet that shows the expected weekly cash receipts and payments. These are presented line by line and tracked weekly.

To create the forecast requires beginning cash balances, estimated cash receipts, estimated payroll and taxes, estimated operating expenses, payments coming due on notes and leases, and lines of credit.

Creating and updating a 90 day cash flow forecast provides numerous benefits:

  • Visibility into your short-term cash needs
  • Financial discipline in measuring your inflows and outflows of your business; i.e., “What gets measured, gets managed.”
  • Insights into your operations and its short-term flow of activities

Estimating Cash Inflows and Outflows

Inflows

Estimating cash receipts for a 13-week period is one of the more difficult components of the model.  Whether your customers pay in a timely manner is typically a function of their own cash flow positions.  Don’t be deterred from making your best estimates, knowing that actual receipts will differ from your estimates. Use recent payment performance of each customer as a guide.

Depending on the number of customers involved, you may want to create a line on the spreadsheet for your largest customers to identify their specific collection pattern independent of the rest of your customers. Alternatively, if your customer base has numerous small customers, you may want to create a separate tab that provides a general pattern of collection from your monthly sales.

Outflows

Payroll and related taxes are generally easier to estimate because for most businesses, the figures may not change much week to week or they change in a predictable manner. Payrolls that include commissions are more difficult to estimate.  One way to estimate commission would be to obtain a historical trend of commission expense as a percent of sales. Then using this percent apply it to the collected sales or billed sales (whichever the commission is based on) subject to commission and put the amount in the period you expect to pay it.

Cash outflows for accounts payable and operating expenses can be easier to forecast.  We recommend laying out the general timing of when you typically pay an expense. For example, office rent is typically due on the 1st of each month.  In this case, you may show the payment as an outflow in the last week of the prior month to ensure the check arrives on the due date.  If you see headwinds ahead in your cash flow, keep your vendors apprised of your ability to pay and reward their patience as best you can.

Stay in Control of Cash Flow

Business conditions change quickly today.  Keeping a tight rein on cash flow is a small business survival skill and the life blood of a company. The 90-day rolling forecast is a good tool that can help you stay in control of your cash flows. For a forecast to be accurate and relevant, it should be monitored on a regular basis and updated with forecast compared to actual. See where the differences occur and adjust your forecasting for any trends that you see. When the forecast is used this way, it becomes a tool for active management of a business’s cash position.

If you need help putting together your forecast, contact us or check out our Cash Flow Tool Kit

Forecasting Cash Inflow: A How-To Guide

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Cash flow is the lifeblood of any business. And forecasting cash inflow from customers? Well, that gives you the ability to truly own your numbers and grow your business.

Building a cash flow forecast includes several components, from customer inflows to the numerous outflows with employee expense, vendor payments, and bank loan repayments.

In this Numbers Coach TIP, we are going to focus on a few methodologies to determine customer inflows and how to forecast them. I have used the following methods depending on the client’s business model:

  • Payment pattern by each customer
  • Sales pattern flow
  • Collection pattern flow

Customer Inflow Forecast Method #1: Payment Pattern by Customer

In this method, we layout by customer the expected timing of when we will bill them and then allocate their payment to the month they have paid based on their history. In this case we are plotting out when each customer will pay during the forecasting period being analyzed. This typically works well when you don’t have a lot of customers and the services or products that you provide to them are recurring.

Customer Inflow Forecast Method #2: Sales Pattern Flow

In this method we layout the forecasted billing based on the period being forecasted (month, quarter, year). Then using our average collection cycle metric, we plot the collection of the sales based on the average cycle length. For example, if it takes on average about 30 days to collect our accounts receivable, then if I plot billing in February for $20,000, then I would show the collection of this amount in March.

Customer Inflow Forecast Method #3: Collection Pattern Flow

In this method we layout the sequence of how much of the billing is collected in subsequent months. For example, January billing we analyze how much of it gets collected in each subsequent month from February through December. In February we might collect 50% of the January billing. Then in March we might collect another 30% of January billing. In April we might collect 10% of January billing. We layout this collection pattern and choose several billing months to analyze and then use the average in our forecasting calculations. This method takes more effort and possibly more time due to the need to dig into the details of your collections.

Whichever method you use, by at least trying to calculate your forecasted inflows, you will gain the knowledge on what works and what does not to fine tune this critical element of your cash flow forecasting. No matter how accurate your forecast, you will gain insights into your business to help you make better decisions.

Want More Cash Flow? Check your Accounts Payable Cycle

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Understanding the levers that drive your company’s cash flow can be the difference between staying in the game or closing up shop. A business can have positive net income, but still come up short of the cash it needs to keep the doors open.

One of those metrics that can cause a lack of cash is your accounts payable collection cycle. It’s one of the four key pillars that drive cash flow.

Accounts Payable Cycle

Some company’s vendors offer the ability to buy their products or services and pay them later. Offering this credit is like getting a short-term interest free loan from the vendor. As part of the deal, your vendor will want to get paid back based on the payment terms they offered. Understanding how long it takes for you to pay vendors is critical to your cash flow.

How do you measure it? Below is a formula that calculates your accounts payable days to pay cycle. Like the accounts receivable collection cycle, this calculation is based on a “snapshot in time” and you will want to monitor it on a regular basis such as monthly.

Formula:

Total expenses / 365 days= daily expenses
Accounts Payable / daily expenses= days to pay cycle

Example:
$900,000 / 365 days= $2,465 daily expenses
$50,000 / $2,465= 20 days to pay cycle

In the above example it takes approximately 20 days for the company to pay its expenses. Some expenses are probably paid upon receipt and other expenses may offer up to 30 days or more to pay. If this metric could be stretched from 20 days to 30 days the company would retain approximately $24,000 in its bank account. This could give it more time to collect accounts receivable from its customers and allow it the cushion it needs to pay bills on time and feel comfortable meeting its obligations.

How could it stretch the days without upsetting its vendors? A couple of strategies:

  • Ask vendors for longer payment terms
  • Use a company credit card to “time” the payment to a vendor. Most credit card providers give you up to 30 days after your statement ending date to pay the outstanding balance. Depending on the timing of your payment, this can add up to 30 to 45 days more time to pay.

Know your accounts payable payment cycle. Monitor it on a regular basis and look at strategies to extend it while working with your vendors to pay within the agreed-upon time. The right accounts payable payment cycle could be the difference between positive or negative cash flow!

Cash Flow Tips For Uncertain Times

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I’ve been watching the news and talking with colleagues and clients and wanted to share some strategies with you that may come in handy as you navigate through uncertain times.

Consider these cash preservation ideas…

  • Research refinance options for any high interest loans and ask for some or all of the closing costs to be waived.
  • The Small Business Administration has created a program to fast track low interest loans under its Economic Injury Disaster Loan, visit: www.sba.gov/disaster
  • Reach out to your lenders about deferring payments, or reducing to interest only payments, on debt.
  • Ask your landlord if you can pay rent at the end of the month (in arrears) for the next 90 days.
  • Ask your landlord about reducing or deferring Common Area Maintenance (CAM) charges for the next 90 days.
  • Call clients to see who can pay faster/earlier.
  • Call vendors to see if you can get extended terms or defer some portion of invoices to a later date.
  • Ask vendors to take payment on a company credit card.  Ask the vendor to charge the amount just after the credit card statement drop date.  This can defer a payment from 15-45 days if timed correctly.
  • Reach out to your credit card company to ask for reduced or zero interest for the next 90-120 days.
  • Bill customers as quickly as possible.
  • Consider whether you have any customers who might pay now for future delivery of services.
  • Defer your personal tax return filing and payment to July 15th.  The IRS issued recent ruling that is allowing a delayed 2019 tax filing until this date.  However, if you are owed a refund file your return now to get the funds.

If you think of other ideas, I’d love to hear them!  My belief is that we will come out of this stronger and definitely together when times are tough.  Stay well and here’s to more cash flow coming into your company!

Mike

Want More Cash Flow? Check your Accounts Receivable Cycle

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I sometimes hear from business owners that they are making a profit, but they don’t seem to have positive cash flow at the end of the year. What happened?

Your business may generate a positive net income, but if you aren’t monitoring other key cash flow drivers, then you can find yourself strapped for cash to meet the obligations of the business.

One of those drivers that can cause a lack of cash is your Accounts Receivable (A/R) collection cycle. It’s one of the four pillars that drive cash flow (along with Accounts Payable, EBITDA, and Inventory Days-on-Hand)

Your Accounts Receivable Cycle

Many businesses offer customers the ability to “Buy Now, Pay Later” for their purchases. In other words, they are providing customers a short-term interest free loan to pay for the product or service! If your customer doesn’t pay on time or takes longer than you expect, it can create a cash flow problem in your business.

Monitoring how long it takes for you to collect your accounts receivable is important. The quicker you can collect it, the quicker you get the cash you need to pay your bills and reinvest for your company’s growth.

But how do you measure it? Below is a formula to determine your collection cycle. Keep in mind your cycle will shift weekly, monthly, quarterly, etc… The calculation is merely a “snapshot in time,” but it’s important to know.

Formula:
Annual sales / 365 days= daily sales
Accounts receivable balance / daily sales= days to collect accounts receivable

Example:
$1,000,000 / 365 days= $2,740 daily sales
Accounts receivable $80,000 / $2,740= 29 days

In the above example, it takes on average about 30 days to collect the amounts owed by the company’s customers. If this metric increases from 29 days to 39 days, then the extra 10 days has left the company with $27,400 less cash in their bank account than if they had collected it in 30 days. This is where the business owner could see a positive net profit in the profit and loss statement, but also see that their cash balance has decreased by $27,400.

Know your accounts receivable collection cycle. Calculate it on a regular basis, such as monthly. Identify customers who are consistently not paying on time and determine a strategy to encourage them to pay within the terms you have offered. It can be the difference between positive or negative cash flow!

For more resources to help you measure this important metric, check out our Numbers Coach tools and templates.

Want More Cash Flow? Check your EBITDA

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The life blood of any business is its ability to generate solid cash flow. Without positive cash flow, a company will eventually go out of business. This TIP will focus on one of four key pillars that drive cash flow. In this case we will look at “Earnings Before Interest, Taxes, Depreciation, and Amortization,” or more commonly known by the moniker EBITDA.

Where do you find this metric? One of the financial statements that you can get from your accounting system is the profit and loss statement. The very last number of this statement is typically labeled “net income.” Net income is the profit you have left over after paying all your expenses. When we add back to net income the interest expense, depreciation expense, amortization expense, and income tax expense we get the number for EBITDA.

EBITDA formula:

Net income +

  • Interest expense
  • Depreciation expense
  • Amortization expense
  • Income tax expense

= EBITDA

EBITDA is important for two reasons:

  1. It is a general indicator of your company’s ability to generate cash flow from the operations of your business
  2. It is used as part of the formula for valuing a business. Often someone who wants to buy a business will value it based on a “multiple” of EBITDA. In other words, they are buying your company’s ability to produce cash flow now and into the future.

To generate positive cash flow, you need to have a positive EBITDA. Otherwise, you are generally finding yourself starting your cash flow conversation in the negative position and will likely need to borrow money or find investors to provide capital to keep the company going.

Start with a positive EBITDA number and you can be more confident with your company’s ability to generate positive cash flow. Do you know your EBITDA?

Let us know if we can help you with this important metric.

What’s the Deal with Working Capital?

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A Unique Look at Asset Based Lending
by Marc Smith

“Cash is King.”  We’ve all heard the expression, but if you haven’t owned your own business, you likely haven’t given it serious thought.

When a business is for sale, most people first want to know about the total revenue (sales) and the net income (profit).  These two factors are extremely important, but any business owner would argue that there is another factor that is even more important than these two:  Operating Cash Flow or Working Capital.  Profits are great, but no matter how much money is coming in the future, a business can’t continue to operate if it doesn’t have enough cash to cover this week’s payroll.

Let’s use an example of a recent business acquisition: 

XYZ Company is acquired by an eager buyer who uses an SBA Loan to finance the transaction.  Everything starts out great for the new owner:  their new business is growing, sales are up and they are enjoying the rewards of self-employment.  XYZ Company has many new orders to fulfill or new contracts to service as a result of this growth.  The working capital associated with this expansion are typically paid up front while the company won’t receive the benefits until the customer remits payment (sometimes months down the road).  As the new opportunities develop, the up-front costs associated with these opportunities keep increasing.  Before long the owner is looking at a significant cash gap from what is owed to suppliers now versus the cash that customers will not remit for another 30-45 days or more.

The owner realizes that with the recent growth, there is a need for a line of credit.  Obtaining additional funds or refinancing with the SBA Lender typically isn’t an option, so they inquire with their local bank for conventional financing.  This presents a problem:  all business assets are already collateralized with the SBA Loan, leaving the bank with no collateral.  Therefore, the bank is not willing to extend the company a line of credit.  This leaves the owner in quite a predicament:  sales are up and the future looks bright; however, the short term cash flow constraints are keeping the company from taking advantage of that growth.

Profits are great, but no matter how much money is coming in the future, a business can’t continue to operate if it doesn’t have enough cash to cover this week’s payroll.

– Marc Smith

It is this type of situation that can potentially be resolved with an Asset Based Loan.  Typically secured by Accounts Receivable, an Asset Based Loan provides working capital to a business.  It does not add cash to the business, it simply accelerates cash flow by allowing a business to borrow against the future value of its receivables that are expected to become cash in the near term.

The SBA Lender is many times willing to “release” the Accounts Receivable to the Asset Based Lender because this provides the company with additional liquidity.  By working with the Asset Based Lender, the company now has the capital it needs for growth without worrying about how it will meet its short term cash demands.

Marc Smith is a Vice President with Magnolia Financial, Inc., an Asset Based Lender that provides Accounts Receivable Financing and Management to growing companies that are typically unable to obtain traditional bank loans.  He can be reached at msmith@magfinancial.com or (404) 664-7037.

What Your Inventory Turnover Ratio Is Telling You

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Bankers who lend to small businesses in manufacturing and distribution often calculate a client’s inventory turnover ratio. “What are the bankers looking for in a ratio?” clients sometimes ask.

First, bankers wonder whether the business is carrying inventory that is disproportionate to its sales. Carrying excess inventory is not a productive use of capital when money is tied up in product that sits on a shelf and incurs warehouse costs.

A second concern for lenders is that inventory not turned over quickly will become obsolete, damaged, or outdated. In any of those circumstances, revaluation of the inventory is necessary and losses must be booked. That’s a concern to lenders.   Also a decreasing turnover rate could indicate a slowing sales and lower profit trend.

Calculating the Ratio

The ratio is only difficult to calculate if a business’s inventory varies significantly throughout the year. Inventory Turnover is calculated as Cost of Goods Sold divided by Average Inventory. The Cost of Goods Sold is always calculated for the Income Statement, so the figure is readily available. Average Inventory may be trickier. For businesses with fairly constant inventory levels, simply add Beginning Inventory to Ending Inventory and divide by two to calculate a simple average.

This simple average doesn’t always work well, however, because many businesses have significantly less inventory at the beginning and end of the year than at other times. The simple average, therefore, uses an artificially low denominator, which tends to overstate the Inventory Turnover Ratio.  So, if monthly inventory figures are available to calculate the average their use will provide a truer Inventory Turnover Ratio:

Using information from the table above, we can calculate Lerner’s Inventory Turnover Ratio for 2012 and 2013. The ratio is determined by dividing Cost of Goods Sold by Average Inventory for each year. For 2012, the calculation is 19,726,396/3,936,307=5.01. For both 2012 and 2013, Lerner turned over its inventory slightly more than five times per year. Bankers interested in Lerner’s Inventory Turnover Ratio would likely compare the Lerner ratio against those of other companies in the same industry. A turnover ratio significantly below those of Lerner’s peer group might cause bankers concern about inventory obsolescence.

Let us know if you would like to see how your ratio stacks up against those of your peers, or to discuss how to improve your ratio.

Reassess Your Customer Credit Practices for Stronger Financials

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by Anne Moore Odell

Every time you send out an invoice, it is like you are granting a loan to your clients. Business is built on trust with products and services moving around the world on the foundation that invoices are going to be paid in a timely manner.

However, extending credit can’t happen in a vacuum. It is up to you to create credit policies that keep your cash flow and business healthy. And while having good credit practices in place is always important, it is especially important to make wise credit decisions in today’s difficult economic times.

Here are 5 tips to help you create sound credit policies:

 1. Take the Time to Research

Now is the time to revisit your credit application process. Make sure that your application is thorough. Make the effort to call all supplied references and banks. Although clients are only going to supply positive references, you can still learn a lot about how potential clients work.

Do your homework on prospects by going to the library where free information from publicly traded companies can be found. Consider using a professional credit report service like Dun & Bradstreet , TransUnion or Equifax. For a small fee they can provide credit histories, records of liens against companies, and current financial obligations on larger clients.

“Don’t forget to use your contacts with the various business associations you belong to – they can help gain information about credit decisions,” suggests Mike Iverson, CEO of Trillium Financial. “Through these relationships and through relationships with other vendors, you can learn about potential clients. You might also require information from clients’ accountants, and tax returns,” says Iverson.

2. Consider using a Z-Score 

A Z-Score is a calculation that allows you to figure out the financial health of a company by using ratio values for a “score” that can indicate potential future bankruptcy. A Z-Score calculator can be located at either The Accounts Receivable Network (membership site: www.tarn.com) or at JaxWorks (http://www.jaxworks.com/calc2a.htm )

3. Be Selective

Keep your customers’ credit files up to date. With businesses going bankrupt and changing hands, it is important to update your credit information on existing clients, increasing or decreasing credit limits as needed.
“In this market you need to be discerning regarding who you are offering your services and products to,” says Marc D. Smith, Vice President, Magnolia Financial, Inc, based in Spartanburg, SC. “Fire customers if they don’t meet your credit requirements.”

Because of the reduction in sales that many businesses are seeing across sectors and industries, businesses are facing increased pressures when it comes to extending credit. However, just because a client is interested in your product or service it doesn’t mean that you need to accept every application.

“In my experience, people are lowering some of their credit limits,” says Iverson. “You should consider your accounts receivables to be much like an investment portfolio—you have invested in your customers and you want your portfolio to be profitable.”

Working with customers before problems and outstanding invoices occur is the best approach. In some cases, you can work out new payment schedules. It is also important to include your entire team so that salespeople know clients’ credit and payment histories.

4. Follow Up

“In good or bad times, one of the keys to collecting from customers is timely and accurate billing,” explains Mike Iverson, CEO of Trillium Financial. “That sounds like a no brainer, but sometimes that doesn’t happen. An invoice might have to be approved or reviewed by several different people, which can cause you to lose two, three, or four days in collecting your invoice.”

One effective practice for larger bills is calling to follow up on an invoice two or three days after it is sent to see if everything is in order. This practice not only puts you top of mind with your client but acts as a customer service call that could generate more sales. If the client does have an issue with the bill, then you can quickly solve the problem, generate another invoice and get paid on time.
Another proactive practice is to send monthly statements or even bi-weekly statements, again reminding clients before bills become overdue.

5. Good Relationships are Important

All levels of management are becoming more involved in credit decisions as businesses look to keep the cash coming in. These days CFOs and CEOs are participating in credit decisions with their teams.

One of the main points to remember, however, is that while economic downturns will end, the relationships you form today will continue. Working to preserve the business relationships you have now and creating new working relationships not only generates good will, but also builds a strong foundation to catapult your business when the economy rebounds.

Your Best Tool for Understanding Short-Term Cash Flow

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In a recent article, I shared ideas on how to positively position your company’s financials, even during a slowing economy.  The key is to ensure you have strong cash stores and credit availability.

Today, I will explain a management tool that helps you anticipate your near-future cash flow and identify any areas of weakness: Presenting the 13-Week Cash Flow Analysis. 

You may already use software that allows you to run regular cash flow analyses. These give a more accurate picture than net profit or bank statements.

Initiate your 13-week cash flow analysis by gathering the data needed to build an accurate report:

  • Current bank account and credit card balances
  • Upcoming mortgage or lease payments
  • Estimated cash receipts
  • Estimated payroll and taxes
  • Estimated operating expenses
  • Any other upcoming transactions that will impact cash flow.

The integrity of the report is dependent on the accuracy of the data as well as it being correctly entered or integrated into a spreadsheet or software. For the variable revenue and expenses you estimate, be sure to keep seasonal influences in mind. And remember, you only need to record and predict 13 weeks out – it’s a short-term tool.

A report with solid data and estimates is a good indication of your cash situation over the next 3 months (or, one full quarter). But check the output against your gut:  If the balance seems overly positive in any or all of the 13 weeks, review your estimates, especially sales and accounts receivable forecasts. Being overly optimistic won’t serve you well – if anything, conservative estimates will give you the padding needed to accommodate unpredictable changes.  If you have the time, run worst-, best- and average-case scenarios.

If the report indicates that your company will be cash poor at points during the next 13 weeks, it’s time to review your options:

  • Do you have unneeded equipment or inventory that can be sold to improve fluidity?
  • Are there expenses that can be eliminated, contracts that can be renegotiated or even dissolved, or payments negotiated or delayed?
  • Is it time to implement a collections push?
  • Is your billing and collections process quick and accurate?
  • Are there any loans available to the business?

Once it is set up, maintaining cash flow history and projections is easy. Monitor and update the report weekly, and review your historical projections against actuals to improve your modeling accuracy.

Cash and cash flow are critical to successful operations, and utilizing 13-week cash flow analyses will help you identify gaps and become better at anticipating your future cash needs to keep your business steady. So make proactive cash flow analysis one part of your flexible, resilient business, whether the economy and your customer demand are swinging up, down, or somewhere in between.