We are often asked by business owners, “Why the emphasis on cash flow?” And our answer is "because a company can highly be profitable, but still go out of business if they don't pay attention to cash flow", at which point I can see their amusement and a question mark on their face. Then I follow with a little story to better illustrate my answer.
Let me introduce you to a concept that we can call 'the speed of cash': Your company, your sales can grow so fast that you run out of money!
How is this possible?
A Story of Cash Flow
Let's take the story of the product called "Perfect Pushup". This product was a dream product for any entrepreneur, it was wanted. It was on As seen on TV, on Target shelves, on Costco shelves, on Walmart shelves, you name it.
But getting those big contracts to fulfill could sink any company. With the proper Strategic Advising Service, you get the help to make those decisions.
Here's what happened to the Perfect Pushup. The first year they had two millions dollars in sales. These big stores were ordering the product, but they weren't paying on delivery; they'd pay 90 or 120 days later (as per contract).
The stocks of products in these stores' shelves ended up selling out in a week. So they reordered right away (on the 2nd or 3rd week). And that's exactly what you want them to do, you want your product to sell fast.
But when these stores reorder, you on the other hand have to pay your rent, your employees, your taxes, your vendors in order to get the goods back in and manufacture more products. This circle goes on over and over again, and this is where, while you wait for your customers to pay you, that you can run out of money.
The second year, the Perfect Pushup company did sixty million dollars in sales, and almost lost everything. Yes, almost lost everything because they ran out of cash. They couldn't fill the orders, and they were at the point where they couldn't pay operational bills and payroll. But, with creative financing they were luckily able to solve it. If they had had the right tool and had analysed their cash flow, they could have avoided all the hard times.
With the proper tools and advises, you can get the help to make those decisions. With the Virtual CFO tool, Onyxia Accounting can help you. You will get help understand if you have enough money to actually fulfill a project or contract.
Let's define Cash flow
Cash flow, simply put, is the measure of how much cash is moving in or out of your business in a given period of time. For example, during one month, you might pay $5,000 in bills and receive $8,000 in cash from your customers. In this case, your total cash flow would be $3,000. Calculations are as simple as:
Cash Received – Cash Paid Out = Cash Flow
You can read a little more about the differences between Cash Flow and Profits here.
The following 3 levers impact and control Cash Flow (the speed of cash):
The amount of time inventory sits on your shelves (Inventory Turnover);
The time your customers take to pay you (Accounts Receivable turnover);
The time it takes you to pay your vendors (Accounts Payable turnover).
Let's say you manufacture a mobile phone cover and that Best Buy passes an order with you. After the first batch of orders are produced and shipped, what you need to do is make sure you have enough money to continue producing and filling the second and third batch of orders while you're waiting for Best Buy to still pay the first batch of orders. At some point, it can get very difficult and you can run out of money.
This is where analyzing your cash flow can solve the problem of growing broke.
Inventory Turnover
Inventory turnover is a ratio showing how many times a company has sold and replaced its stock of goods (inventory) during a given period. A company can then divide the days in the period by the inventory turnover formula to calculate the days it takes to sell the inventory on hand.
You can improve cash flow by improving inventory turnover. With the right set of reports, you can find your top selling items, which customers buy them and which ones don't, and trigger actions:
email and call those customers letting them know about these top selling items that they aren't buying. Just a little FOMO (Fear Of Missing Out) to bump up sales and move inventory.
There are other examples out there of how you can pull that inventory turnover lever to improve cash flow.
A/R Turnover
One way of getting paid faster is to get more aggressive about collections. However, you run the risk of upsetting relationships with your customers. You can offer incentives, review your credit terms, etc... I invite you to read this: improve your accounts receivable turnover.
In a past job of mine, an engineering advisory firm, I once suggested to the 2 business owners, my bosses, to drop a certain type of customers (grocers), because for the type of advisory and efficiency studies we were doing for them, they were terrible at paying, taking as long as 6 and 9 months to pay us. Eventually, my bosses did and replaced these type of customers with others that ended up paying in 30-45 days. Bam! Sometimes the solutions is right in front of us and we don't see it.
A/P Turnover
Just like with the A/R, this is a lever you can pull at the risk of upsetting your vendors. During your business activities, you might have to work with a company (usually larger ones) that take 60 days, even 90 days to pay you. This is an example of a company using their A/P lever to improve cash flow. Bigger companies can get away with this because
you need them more than they need you.
Remember that when you use the A/P lever, you are doing so at the expense of someone else’s A/R lever.
Right tools
Cash Flow is critical for every business no matter what the industry. 50,000 businesses file bankruptcy every year and that doesn’t include the businesses that close without filing. In every case it’s because cash flows weren’t sufficient to keep up with the obligations of the business.
What we want is give you the tool that puts this information right into your pocket, equip you with the knowledge so you can make the decision on whether or not that contract is right for you at this time, or prepare for it in the future. You're gonna know how to control the levers, you're gonna understand the money gymnastic and the cash shortage that you might have should you get the contract.
There are many advantages to our Virtual CFO service, or Stategic Advising service, (#virtualCFO) have a look for yourself! And if you aren't sure what these means to you and your company, do not hesitate to ask us explanations or even how your company could benefit from it.
That’s why we keep saying, "#cashflow"!
Nadine LeBrun
President & Founder
Onyxia, Comptabilite | Accounting