Tackling the Cash Flow Problem - Part 3 of 3

In parts 1 and 2 we saw how variable cost control presents a very real and sizeable challenge for most businesses. In our small business example we needed to finance 150% of our monthly profits each month just as a matter of normal business. You can imagine what the situation starts to look like if orders come in late in the month, or customers don't pay their bills on time.

Below we paint the financial picture of our small business example from two different perspectives. Both tell the same story, but one is from a balance sheet perspective, and the other from a cash flow perspective. The only real difference is that the balance sheet includes money promised as well as real money. The cash flow picture only shows real money coming in or going out. They both end up in the same place, but paint two very different pictures of how we got there.

Balance Sheet Money
Day 1 Order Taken for $10000, Balance = $10000
Day 2 Get materials from vendors (-$3000), Balance = $7000
Day 2 Sign assembly staff contract (-$3000), Balance = $4000
Day 15 Product Delivered, Balance = $4000
Day 15 Pay staff the $3000 we owe them, Balance = $4000
Day 30 Pay vendors the $3000 we owe them, Balance = $4000
Day 45 Collect payment owed to us for $10,000, Balance = $4000

Real Cash
Day 1 Order Taken for $10000, Balance = $0
Day 2 Get materials from vendors (-$3000), Balance = $0
Day 2 Sign assembly staff contract (-$3000), Balance = $0
Day 15 Product Delivered, Balance = $0
Day 15 Pay staff the $3000 we owe them, Balance = -$3000
Day 30 Pay vendors the $3000 we owe them, Balance = -$6000
Day 45 Collect payment owed to us for $10,000, Balance = $4000

Understanding the difference between these two scenarios is a critical management skill. A company's ability to survive quite literally depends on the smart management of cash flow.

Cash Flow Management Tips

So let's look at the 4 big management tips to keep your cash flow situation running smoothly.

Delay payment to your vendors as long as you can. Ideally you don't want to pay your vendors until after you collect from your customers. Very few businesses manager to arrange this, but the longer you can put off paying your vendors, the healthier your cash flow situation will be.

Collect payment as soon as possible. The sooner you get money from your customers the healthier your cash flow situation is. And when customers are late paying, make sure you are calling them to find out why.

Ensure you have adequate financing to handle the size and duration of orders you are taking. Factor the cost of financing into your financial equations.

Get the most accurate orders forecasts you can. This is critical to managing daily fluctuations in any production environment. Imagine what happens to our cash flow if we over produce and have to pay for things we don’t sell for a long time.

Summary

One of the biggest daily challenges of most businesses is cash flow. Most often variable costs make up the bulk of the money coming in and out of a business, and hence the bulk of the cash flow problem. You must learn not only the numbers, but also the timing. In the world of variable cost, cash flow cost control, timing is everything. Learning to manage time and money well together is one of the most practical management skills you can ever learn.