This is the first in our series of articles on the ‘Seven Key Numbers that drive Profit and Cashflow’.
The seven Key Financial Drivers are:
- Revenue Growth %
- Price Change %
- Cost of Goods Sold%
- Days Receivable
- Days Payable
- Days Inventory/Work in Progress
The Key Financial Drivers
Key Financial Drivers in business are what drive the results. The ones we’ve listed can have a huge impact on business financial results. A small change in any one of these can have surprising results, as we will illustrate later in this article.
More sales can’t be a bad thing you would conclude and in many cases it’s great … BUT it entirely depends on your Cash-Flow Cycle. That is the length of time it takes for cash to land in your bank account after you’ve made a sale and the time you’ve had to outlay cash prior to selling it. You can work out the Cash-Flow Cycle that affects your business as we have done in the diagram below. It’s smart practice however to know about the most prolific, age-old question accountants get asked by business clients, it is …
“How come I’ve made more profit, but I don’t have anymore cash?”
The ‘Cash-flow Cycle’ is often overlooked by small business owners until business starts to grow and they begin to experience ‘cash-flow squeeze’.
Let me explain how it works. In the diagram below you can see a timeline of 365 days.
The diagram shows:
- On day 1 – before you sell anything you have to buy something i.e. stock or it could be labour for a job
- On day 60 – depending on your sales cycle i.e. how long the stock sits in store, you may hold onto stock for 60 days.
- On day 31 – depending on the terms you get from suppliers you may have to pay for that stock after 30 days – which means you have 30 days negative cash-flow.
- Day 120 – depending on your accounts receivable management you could wait 60 days to get paid – which adds another 60 days negative cash-flow.
- This adds up to 90 days negative cash-flow.
This means the money has been somewhere other than your bank account for 90 days i.e. in the bank account of your supplier and your customer.
This is referred to as ‘funding the sale’. This is also known as ‘working capital’, which means that you need to have a certain amount of money to fund sales all the time.
The above causes a problem when growth occurs because the issue just gets bigger. If a business isn’t working to minimize the number of days stock is in store and the number of days customers are taking to pay then the problem just gets worse when sales grow. They also need to work on maximising the number of days they can take to pay suppliers.
Sometimes businesses get very focused on increasing sales and the issues of stock movement and accounts receivable get ignored or are not considered worth investing in. This is why growth can often kill what appears to be a good business.
In a ‘service based’ business jobs or ‘work in progress’ can cause cash flow squeeze if billing and payment terms are not well managed. It pays big time to calculate a billing and payment programme with customers, taking into consideration the payment for materials and labour on a job.
The ideal is to ask for a deposit up-front to cover as much of material costs as possible, then progressive payments to cover labour if the job is in progress for a while.
A lot happens to cash on its journey from the sale to your bank account. If you are planning to grow your business you must understand this phenomenon or you could be heading for problems.
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