Archives for May 2013

The Cost of the Cash Gap

This is an Article I help create that was recently posted on The Business Finance Store Newsletter.

Posted on  by Samantha Hadley

In a recent post about the cash gap, we provided an example of a company with an 80-day cash gap.

Example:

Example: ABC Company LTD
Inventory = 60 Days
Payables = 30 Days
Receivables = 50 days
Cash Gap (60+50) – 30 = 80 Days

Now, look at the financial cost this cash gap has on the company.

Cash Gap = 80 Days

Annual Sales: $1,000,000
Daily Sales: $1 million/365 = $2740 in daily sales
Gross Profit Margin: 35%
Cost Of Sales: 100% – 35% = 65%
Daily Finance Required: $2740 x 65% = $1781 cost for daily sales
Working Capital Required: ($1781 x 80 = $142,480)
Plus interest if borrowed:  (10% x $142,480= $14,248)
Total Capital to fund operations: ($142,480 + $14,248 = 156,728)

This business requires an additional $14,248 annually to cover the interest alone on the $142,480 of working capital they require. However, lets look at the same business, if their cash gap were reduced to 50 days, rather than 80 days.

Annual Sales: $1,000,000
Daily Sales: $1 million/365 = $2740 in daily sales
Gross Profit Margin: 35%
Cost Of Sales: 100% – 35% = 65%
Daily Finance Required:  $2740 x 65% = $1781 cost for daily sales
Working Capital Required: ($1781 x 50 = $89,050)
Plus interest if borrowed: (10% x $89,050 = $8,905)
Total Capital to fund operations: ($89,050 + $8,905 = $97,955)

This company has now saved $5,343 annually in interest and $58,773 in operating costs, simply by reducing the cash gap. So how do you reduce the cash gap in your business?

Increase Payables Period

What does this mean? It means the time you receive from your suppliers before you have to pay them. The most common trade-term offered is 30-days. Do not be afraid to negotiate and ask your suppliers for this time. You are their customer and they need your business as much as you need theirs.

Another way to increase your payables period is to utilize credit or charge cards in your business. Using a credit card to pay for goods from your supplier will provide you with a 25-day interest free period. Research the different options on the market today as some business charge cards offer up to 55 interest free days. Nate Thorne of CFO OnCall LLC also advised that paying credit cards off each month eliminates interest payments as well.

Decrease Receivables Period

What does this mean? The time your customers take to pay you. There are several ways to entice customers to pay earlier. If you have some room in your profit margin you can offer customers a discount such as 1% to pay at the time of purchase. As well, accepting credit cards from your customers allows you to receive your money quicker, while offering payment terms.

Nate Thorn also suggested being proactive in your receivables. If you have customers that usually pay in 30-days, call them ten to 15 days early to remind them of the payment coming up. This will help reduce the amount of customers paying you late.

Increase Inventory Turnover

Out with the old and in with the new. Do you have specialty product that has been sitting on your shelves forever? Sell it at a discounted prize and purchase inventory that sells faster.

These are simply three ways to reduce the cash gap in your business. The cash gap can be costly and a growing business with a growing cash gap is deadly. Factor this gap into your business plans, pay attention to it and ways it can be reduced. Create a cash flow budget, keep it up to date, plan for gaps and be prepared, so the cash gap doesn’t take over your business.

http://bfs.ag/589253/2950

The Cash Gap: Identifying and Eliminating It

By Samantha Hadley

The cash gap exists in all small businesses. It is the time between you paying for your product or materials and the customers’ payment clearing into your bank account. For many small businesses this cash gap could extend from 30 to even 90 days. During that time, businesses are financing the money through lines of credit, credit cards and business loans.

A cash cap can costs a business a portion of their profit. In small business, profit is the only thing fueling you and the businesses growth. This is especially true for businesses that do not factor the cost of money into their profit margins.

“Most companies figure the price of their product like this: (material cost + Labor + selling cost + overhead + profit = Price)” said Nate Thorne of CFO On Call, LLC. Unfortunately this figure does not factor in the cost of financing over time. Although this cost is small on a monthly or daily basis, it adds up over the year.

Over time this cash gap can bleed a business dry. Thorne created his business to offer this kind of advice to small business owners. So far he has found many businesses that are having trouble can begin there, internally in fixing their finances for the future.

How to Calculate Your Cash Gap

Day one will be the day your cash goes out, this is when you pay your supplier for the product. Add the amount of days for the product to reach the customer. Then add the amount of days you provide for your customer to pay you. Your total is your cash gap. (Also illustrated in the picture.)

If your cash gap is 30-days and you are paying 2 per cent per month on your line of credit, over the course of one year, your cash gap is costing you up to 24 per cent of your yearly profit margin.

Eliminating the Cash Gap

As a small business owner there are various ways you can reduce or eliminate your cash gap.

  • Set-up credit terms with your suppliers.
  • Offer cash discounts for customers that pay immediately upon receiving the goods or service.
  • Be proactive in your receivables, if your customer has a 30-day term, contact them at the 15-day mark.
  • Use financing programs that offer you more time, such as charge cards with longer payment terms that are interest free.
  • Take deposits on goods and services to limit the amount of funds you are financing over the period of your cash gap.
  • When pricing products or services, factor in the cost of financing money over time.
  • Develop a partnership with a 3rd-party financier so you get your money sooner and the financier worries about the customers payments.

The cash gap can be detrimental to a small business.

‘When the cash gap is properly managed, a business will make a profit,” Thorne reiterated. Look internally, as well as externally and be proactive in tracking, managing and reducing your cash gap.

Via: Business Finance Store

(CFO On Call UA-38359200-1)