Simple Tips to Improve Your Cash Flow
Most small businesses fail because they run out of cash. It’s as simple (and as tragic) as that. The first step to guard against it is to know how much cash you have at all times. That means tracking it from the get-go. Don’t wait til you’re several months into your business—by then, you’re too busy to set up the systems you need to do it well.
What to track
You’ll want to identify 4 or 5 key financial metrics that affect your cash flow. The most common ones are:
- accounts receivable days (how long it takes customers to pay you)
- accounts payable days (how long it takes you to pay suppliers)
- cost of goods sold
- inventory ratio
By tracking these metrics, you’ll have a good sense of how long cash is taking to come in, how long you can keep it around, and where it’s going when it leaves. Now you can take steps to turn these numbers to your advantage.
Get paid sooner
To improve your cash flow, you’ll want to find ways to get customers to pay you sooner. For example, if customers take an average of 47 days to pay you, set a goal to get your accounts receivable days down to 30 days. A business with sales of $200,000 a year would see a one-time cash improvement of $9,315.
To increase the amount of cash on hand, take more time to pay your bills (increase accounts payable days). For example, assume you have $40,000 in supplier-related expenses every year. If you paid them in 30 days instead of 15 days you’d see a one-time cash improvement of $1,643.
Increase cash from each sale
Set a goal to improve your costs of goods sold (i.e., either raise your price and/or cut your cost of production). Every sale will then generate more cash and increase your gross margin. A company with annual sales of $200,000 that increases its gross margin by 1% (say, from 28% to 29%) will earn an additional $2,000 cash every year.
Reduce your inventory
Every dollar not tied up in inventory is a dollar in your bank account. So, for example, reducing your $50,000 inventory by 5% puts $2,500 back in your bank account.
Add it all up
None of the above examples are extreme, yet they add up to a very healthy cash increase of $15,458. What would you do with an extra $15K in your bank account?