Understanding and managing your cash gap is one of those business fundamentals that you must get right in order to grow a sustainable business.
A cash gap is basically the number of days between a business’s payment of cash for goods or services and the receipt of cash from their customers for goods or services sold.
See this illustration for a visual example:
As you can see it takes this business 90 days to receive cash after they have paid out for stock. Clearly a 90 day cash gap is not ideal, but if this business started to grow dramatically it is quite possible that they would run out of money and go bust.
This is because growth sucks cash; more inventory, more people and possibly larger premises all cost more up front.
Here are some fundamentals to consider in ensuring that you manage and reduce your Cash Gap:
1) Know the numbers!
– Produce a regular and accurate cash flow forecast.
– If cash flow is critical you may need to review this daily or weekly.
2) Review your credit control policy.
– Are you checking out new customers’ credit history?
– Do you have a specific process in place with the appropriate chases and escalations?
– Do you chase frequently enough?
– Do you have the right person doing the chasing?
3) Identify repeat offenders and take action.
– Whether it is reduce or renegotiate terms, reach a compromise, take them to court or stop dealing with them – do something.
– Use your best judgement but you’ll have to change something to get a different result.
4) Understand why your customers are paying late.
– Are you giving them all the information they need to pay?
– Are your invoices clear and going to the right person?
5) Review your terms.
– Consider reviewing your terms if you haven’t done this in a while.
– Think about taking deposits and introducing stage payments if appropriate to your business
6) Negotiate longer terms from your suppliers.
– You may have some leverage here if you are a top spender or if your spend is increasing.
There are so many things you can do to improve cash flow but the starting point is awareness. Good cash flow forecasting helps you to identify problems and solutions. Also, if you need to approach the bank, a cash flow forecast will help you to explain exactly how much you need and why.