When we talk about cash flow, what we are actually talking about is the working capital cycle, which is the cash flowing in a cycle in and out of your business. It’s your business’s life blood and you need to help keep it. If a business is operating profitably, then it should, in theory, generate a cash surplus.
The working capital cycle at its basic level is about who is funding what. While you’re waiting for your customers to pay, you’re funding their business at your cost. The reverse is also true, as while your suppliers are waiting for you to pay them they are funding your business at their cost. The cycle is the difference in time between the two payments.
Any way that you can speed up your customer payments and slow down your payments to suppliers will reduce your cycle.
If you buy 100 laptops from your supplier on 30 day credit terms, they are funding your stock for 30 days. This gives you that time to sell as many of the laptops as you can. If you receive immediate payment, by the end of the 30 days you’ll hopefully have sold enough to pay your supplier and have several laptops left to sell which will all contribute to your profit.
If you were to sell the laptops on 30 day credit terms to you customers from the point of sale, you would face the situation where you were liable to pay your supplier in 30 days, but would not be receiving payment from your customers until after that date. You would therefore have a funding gap between the time to pay your supplier and the time you get paid.
This is known as the working capital cycle – the time periods between cash payments and receipts. They can be long or short – with shorter cycles being better and less costly to fund.
It can be tempting to pay cash when you’ve got it. But if you do pay cash, remember that this is now no longer available for working capital. Similarly, if you pay out dividends or increase your drawings, these cash outflows – like water flowing down a plug hole, can remove the cash liquidity from your business and interrupt your working capital cycle.
By implementing good cash flow management and stock control you should be able to achieve a short cycle, which will ultimately give you a healthier more profitable business with less risk. Even a little effort can achieve bigger results
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