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Cash Cycles – Do you understand yours?

Apr 14Jeff Matthews
Nickels Dimes and Pennies Spread Out

The cash cycle incorporates the time it takes to pay for products and services from suppliers, the time products are in inventory, and the time it takes to collect from customers.  Importers often have to pay for goods at the time of shipment, carry 1-2 months of inventory and wait 30-45 days to get paid.   If the business imports via ocean freight and then ships via truck to its warehouse, the total time from payment to the vendor to payment from the customer can be 30 days on the water, 10 days in customs and ground shipment, 60 days in the warehouse and 45 days more to get paid.  That is 145 days, or nearly 5 months, from the time the business invests in goods until the firm is paid.  Minimizing that cycle is critical to managing the firm’s cash.

Understanding the quality of the assets is just as important.  Some customers pay promptly while others have to be pursued.  Some suppliers offer terms which finance part of the cash cycle, in the above example our days drop to 105 if the supplier requires payment before release from the domestic port.  If the supplier provides 60 day payment terms our cash cycle drops to 75 days.  We also know that inventory does move off the shelf at the same pace.  Some items are tough to keep in stock while others gather dust before they move.  Knowing the mix of receivables and inventory lets the owner know where to turn if cash is required.

Now consider what happens when business picks up.  In Jerry Mills’ book, The Danger Zone, he discusses how increased investment in receivables and inventory to meet rising sales volumes can create a cash crunch.

Managing through a growth-driven cash crunch is just as challenging as a downturn.  Understanding your cash cycle and forecasting cash needs are tools owners need to guide the growing business to financial success.

photo credit: Cha Ching via photopin (license)

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