One of the oldest and most important notions in Business Finance is the statement that “Cash is King”. The purpose of this cliché is to focus examination for a business deal, product decision, or prospective investment on cash flow. This is especially important when the accounting profit & loss is different from the cash flows.
Managing your cash flows is critical for the success of your business. Managing cash flow in your business is an important activity to ensure that you are generating more cash than you are paying out and thus avoiding taking on too much debt to finance your operations.
Maximize your cash flow
Consider the difficulty of running a business where all of the value comes from a future sale of the business to somebody else? What happens if large losses must be absorbed until the future sale? What happens if the future price is lower than your projections? How much of your future are you willing to stake on anticipated gains that may not materialize?
One of the first steps to maximizing your cash flow is to clearly understand how cash is generated in your business and then identify areas where you may be able to improve your cash conversion cycle.
The main sources of cash inflows in a business are the sales. Business with higher cash flows will have a better sales and cash flow conversion plan than those who go about sales haphazardly. Therefore, to be successful in your business, you must ensure that those sales are converted to cash as quickly as possible to accelerate cash flow into your company.
Monitor credit risk
While in business, credit risk might be eliminated completely, building a good credit and collection policy will help to minimize this risk. Once you establish a good credit and collection policy it is important that you adhere to it and monitor it.
One key performance indicator (KPI) that will help you to monitor your cash inflows from credit sales is called Days Sales Outstanding or DSO. The DSO will indicate the average number of days it takes the business to convert credit sales to cash. The formula for calculating DSO can be represented with the following formula:
Total Outstanding Account Receivable divided by Total Credit Sales for the period being analyzed. Next, multiply that by the number of days in the period being analyzed to arrive at your DSO.
Days sales outstanding is an element of the cash conversion cycle, and is often referred to as days receivables or average collection period.
Due to the high importance of cash in running a business, it is in a company’s best interest to collect on its outstanding accounts receivable as quickly as possible. By quickly turning sales into cash, a company has a chance to put the cash to use again more quickly. A higher DSO will indicate that you have a potential problem in collections and a lower number will indicate that you are converting sales into cash effectively.
Here is an example for illustration: Assume total receivables of $1,100,000 and sales of $5,365,000 and a period analyzed of one year. Your DSO would be 75 days which says that it is taking 75 days, on average, to turn your credit sales into cash.
Over time, businesses monitor their DSO to detect changes that may be adversely affecting their cash flow. As you review your own DSO’s, you should look for trends either up or down. A good trend is a declining DSO while an increasing trend is troubling for your business. For example, if your business sells on account at net 30 days and your DSO’s are at 75 days, this suggests there is a problem in your credit and collection activities and action should be taken. Furthermore, if you are required to pay your own bills within 30 days, it will become a much larger problem for your business as this gap widens.
What to do if your DSO’s are trending up?
Here are few things to do if your DSO is trending up:
- Is the credit and collection policy being implemented and adhered to consistently?
- Are you ensuring that customers establish their creditworthiness by performing credit checks or keeping limits lower until they prove they are creditworthy?
- Are you billing customers in a timely manner?
- Are you using an aging schedule and tracking past due accounts closely?
- Are there certain slow paying customers that are contributing to the trend and are you sending dunning letters or contacting them to follow up on past due invoices?
- Are you following up with past due accounts to ensure that the shipment was received and correct?
- Is the economy changing and having an adverse effect on customers’ ability to pay?
By answering these questions, you will be able to assess the reason for adverse trends in your DSO’s and formulate actions to improve the situation and ultimately improve your cash inflows. Take steps to improve your cash inflows, it could be the difference being in business or being out of business.
How to Position Your Services and Create Consistent Cash Flow
Many business owners get stuck when facing cash flow obstacles in their business. This is particularly true if you are a service-based entrepreneur Does that resonate with you? If you’re anything like the small businesses that I work with I know that you want a business and income breakthrough. You secretly wonder what your competitors are doing to consistently attract their ideal clients and maintain consistent cash flow. You’re tired of working way too hard for too little money, and you want the fastest and simplest way to attract more clients, grow your business, and increase your income. Your competitors think differently about the way they offer their services. They understand that their clients are not willing to invest in coaching or consulting, and that what they really want are solutions. Your competitors are adding highly leveraged, lucrative platinum style programs and products to their business model, and that allows them to generate consistent cash flow and have an edge in the market.
As a service based entrepreneur, to increase your income quickly will require you to think differently about the way you offer your services and position what you offer as a solution. Packaging your services into programs and products that provide the answer to your clients’ most pressing needs is, by far, the best way to create consistent cash flow and stop struggling with the feast or famine cycle.