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.

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