How to improve your cash cycle
It’s not what you’re thinking….I’m not modelling cycling shorts as a bet! This is a serious message about the Cash Cycle of your business….in particular….
- What your cash cycle is?
- Why do you need to understand it?
- And ways you can improve it?
1. What is your cash cycle?
In very basic terms it’s the amount of time it takes for 1 unit of currency, say five pounds spent by your business today to come back into your business, hopefully with some profit!
For example a farmers cash cycle is longer than a grocers cash cycle by the very nature of what they do.
The farmer spends cash on seeds, and that cash is no longer available to use, until the end product is sold.
The seeds are planted, grown, harvested, stored and then sold. This takes many months.
So the cash cycle…the time the cash is tied up…is many months long.
Whereas our grocer buys goods with cash one day…and sells them for cash the next.
The cash is then available to use in the business again, making their cash cycle very short.
Do you know how long the cash cycle in your business is?
2. Why do you need to understand it?
Understanding your ‘cash cycle’ is vital to accurately predict the ‘cash flow’ in your business, and how much cash your business needs to operate effectively
Many viable businesses fail through lack of cash.
You must understand how much of your cash is tied up in your cash cycle and for how long. This is one vital element of what we call ‘WORKING CAPITAL’.
3. Working Capital and the Cash Cycle Explained
Think back to farmer Betty…
Her available cash is £70,000
£10,000 is spent on overheads and £60,000 on stock
Her seeds (stock) cost £10,000 every other month on a rolling cycle year in/year out.
Betty must understand what things may delay her? If she has bad weather and the crop is delayed she may be lacking in cash to buy the next lot of seeds. Betty still needs to pay her overheads too.
She has run out of Operating Cash, and therefore Working Capital.
4. How does your cash cycle relate to your cashflow forecast?
Your cash flow forecast should, at least, cover the same period as your cash cycle. If your cash cycle is 3 months long make sure your cash flow forecast is at least 3 months long too! It’s important to remember unusual infrequent bills that perhaps only occur annually such as tax bills.
If your cash cycle gets longer it has a negative impact on your cashflow. Like-wise cash cycle improvements which shorten your cash cycle have a positive impact on your cashflow.
Changes in your cash cycle need to be reflected in your cashflow forecast.
A thorough understanding of your cash cycle and your cashflow forecast will give you better control of your business.
5. How can you improve or shorten your cash cycle?
With these 3 key points:
- Reducing Debtor Days – collecting cash more quickly from your customers. Reducing the amount of time it takes your customers to pay you.
- Increase Creditor Days – the amount of time you take to pay your suppliers. Only do this through negotiation.
- Efficient inventory management – What I mean is controlling your stocks properly. Only buying things when you need to. Don’t let them sit in stock for too long tying up cash.
Improving or shortening your cash cycle is a bit like riding a bike. It’s a matter of balance, tweaks, adjustments, and looking where you want to go.
So is your business like an old fashioned penny farthing? Or is it like a state of the art racing bike worthy of any velodrome champ?