Cash flow is the lifeblood of your business. It's what keeps your business running and thriving. As we tell our clients: ‘Cash is king.’
But even for seasoned business owners, who value financial stability and want their business to run effectively with minimal daily involvement, managing cash flow can seem like a complex task.
As understanding and improving cash flow is essential for long-term profitability and success, here are the seven areas that influence cash flow and the metrics you should be using to understand and measure each area.
In the world of business, selling more products or services generally translates to having greater cash flow. It sounds simple, but the correlation is strong. There are a few exceptions, but on the whole if everything else in your business stays the same and you sell more, there’s a very high likelihood you’ll generate more cash as a result.
Metrics to measure: Look at your monthly sales: How much did you sell (as a dollar figure)? Then, consider any trends. Are sales moving up, plateauing, or trending downward? This will give you a clear picture of where your cash might be headed.
Imagine selling a camera. The difference between the selling price and the cost to get it into the shop's possession (the direct cost) is your gross profit. Focus on increasing this margin, and you will improve your cash flow.
Metrics to measure: Analyse this as both gross profit in dollars (which measures quantity) and gross profit percentage (which measures quality).
Cutting costs seems like the most straightforward way to improve cash flow. It has limitations, but scrutinizing where money goes out the door can reveal unexpected opportunities.
Metric to measure: Examine overhead expenses as a percentage of revenue. A change from 20% to 19.7% could translate into real dollars saved.
It's not just about cutting expenses but buying the exact same product at a better price. If Supplier A offers an item for $10 and Supplier B for $11, the choice is obvious.
Metric to measure: Monitor like-for-like purchases over time to recognise savings.
Getting customers to pay quicker is an art and a science. Those who've bought from you on credit must be encouraged to pay sooner. It's like a gentle dance that leads to more cash.
Metric to measure: Track 'days debtors' to gauge how quickly you're being paid.
Hold onto cash longer by seeking suppliers who offer generous credit terms, like 30 or 60 days. It's a smart way to grow, using other people's resources while keeping ethics intact.
Metric to measure: Look at 'days creditors.' You may find a balance that yields more gross profit by paying sooner but at a better price.
Finally, optimizing stock means increasing cash. If your stock goes up by a dollar, your cash goes down by the same amount. Efficiency is key.
Metric to measure: Calculate 'stock days'—the time between receiving and selling stock.
As you can see, improving cash flow isn't about quick fixes, but strategic decisions that align with your goals and values.
By paying attention to these seven areas of influence – selling more, improving your gross profit, cutting your expenses, buying better, getting your debtors to pay you quicker, increasing your creditors and reducing your stock on hand – you have a roadmap to understanding and improving cash flow.
Remember, financial literacy is not just about having the knowledge but applying it wisely. Taking the time to reflect on these areas within your business will get you one step closer towards business profitability, and, most importantly, financial stability.
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