The answer lies in the issue of the cash-flow cycle. The cash-flow cycle is often overlooked by small business owners until business starts to grow and they experience ‘cash-flow squeeze’.
Here’s an explanation of how it works. In the diagram below you can see a timeline of 365 days.
The diagram shows:
- Before you can sell anything, you have to buy something i.e. stock or labour.
- Depending on your sales cycle, how long the stock sits in store, for example, you may hold on to stock for 60 days.
- Depending on the terms you get from suppliers, you may have to pay for that stock after 30 days, which means you have 30 days negative cash-flow.
- Depending on your accounts receivable management you could wait 60 days to get paid, which adds another 60 days negative cash-flow.
- This adds up to 90 days negative cash-flow.
This means your money has been somewhere other than your bank account for 90 days i.e. in the bank account of your supplier and your customer. This is referred to as ‘funding the sale’.
This is also known as ‘working capital’. Working capital puts you in the position whereby you have to have a certain amount of money to fund sales.
This causes problems when growth occurs, because the issue just gets bigger.
If your business isn’t working to minimise the number of days stock is in store and the number of days customers are taking to pay, the cash-flow problem gets worse when sales grow.
Sometimes, businesses get very focused on increasing sales and the issues of stock movement and accounts receivable get ignored. This is why growth can often kill what appears to be a good business.
Want more articles like this? Check out the financial management section.
A lot happens to cash on its journey from the sale to your bank account. If you are planning to grow your business, you must understand this phenomenon or you could be heading for cash-flow problems.