Story image

How more sales can cause cash flow problems

01 Sep 08

The age-old question accountants get asked by business clients is “How come I’ve made more profit but I don’t have anymore cash?”

The answer to this question lies in the issue of the ‘cash flow cycle’.  The ‘cash flow cycle’ is an issue often overlooked by small business owners until business starts to grow and they being to experience ‘cash flow squeeze’.

Let me explain 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 (i.e. how long the stock sits in store), 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’ which means that you need to have a certain amount of money to fund sales all the time. 

Why the above causes a problem when growth occurs is because the issue just gets bigger.  If a business isn’t working to minimise the number of days stock is in store and the number of days customers are taking to pay then the problem just gets worse when sales grow.

Sometimes businesses get very focused on increasing sales and the issues of stock movement and accounts receivable get ignored or are not considered worth investing in.  This is why growth can often kill what appears to be a good business. 

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 problems.   

Proofpoint launches feature to identify most targeted users
“One of the largest security industry misconceptions is that most cyberattacks target top executives and management.”
How blockchain will impact NZ’s economy
Distributed ledgers and blockchain are anticipated to provide a positive uplift to New Zealand’s economy.
McAfee named Leader in Magic Quadrant an eighth time
The company has been once again named as a Leader in the Gartner Magic Quadrant for Security Information and Event Management.
Symantec and Fortinet partner for integration
The partnership will deliver essential security controls across endpoint, network, and cloud environments.
Review: Blue Mic’s Satellite headphones are good but...
Blue Mic’s newest wireless headphones deliver on sound, aesthetic, and comfort - but there is a more insidious issue at hand.
Is Supermicro innocent? 3rd party test finds no malicious hardware
One of the larger scandals within IT circles took place this year with Bloomberg firing shots at Supermicro - now Supermicro is firing back.
Forcepoint and Chillisoft - “a powerful combination”
Following Chillisoft’s portfolio expansion by signing on Forcepoint, the companies’ execs explain how this is a match made in cybersecurity heaven.
David Hickling in memoriam: “Celebrate the life and the music it made”
Dave was a well-respected presence in the IT channel and his recent death was felt by all the many people who knew him as a colleague and a friend.