One of the most important aspects of maintaining a healthy business is ensuring that the business has strong cash flows. The cash conversion cycle (CCC) is the time span between a business disbursing and receiving cash. The cycle can begin in a variety of ways including performing research and development or purchasing inventory. The cash cycle ends when cash is received for the goods or services provided. It is important for a business to properly manage its CCC in order to ensure that bills are paid on time and adequate inventory levels are maintained.
There are many ways to analyze and improve cash flows. We have come up with the following list of tips that almost all small business owners can consider when trying to improve their CCC:
- Gross Margin – The most obvious way to try to improve cash flows is to improve the margin on the goods or services being provided to customers. This can be done is a variety of ways, including by lowering costs or raising prices. However, it is important to remember that a business must be competitive in terms of what it is charging customers. Likewise, lowering costs could cause the quality of the goods or services to diminish making it difficult to compete with other businesses.
- Speed up Receipt of Cash – Another way to improve cash flows is to try to speed up the collection of cash from customers. Some easy ways to do this include shortening payment terms, offering discounts and enforcing penalties. To shorten payment terms you could, for example, instead of requesting payment within 30 days, payment could be requested within 10 days or even upon receipt. In addition, discounts can be offered to customers who agree to pay for the goods or services up front or within a certain timeframe after billing. Also, penalties can be assessed for those customers who are late making payments.
- Manage Inventory Levels – Managing inventory is a great way to improve cash flows. If a business is able to keep inventory levels so that there is just enough to fill customer demand, this allows purchases from vendors to be smaller while still meeting the demand of customers. Managing inventory can be very cumbersome and difficult. A manager must be able to accurately forecast customer demand and make purchasing decisions accordingly in order to efficiently manage inventory levels. This is often achieved by analyzing data from prior years and comparing it to the current year activity.
- Long Term and Short Term Financing – Different forms of financing are also viable options to improve cash flows. Long term financing is generally obtained for larger purchases. However for short term cash flow issues a manager might consider trying to refinance long term debt so that smaller payments can be made. This will free up cash to be used in other areas of the business. In addition, short term financing such as lines of credit or business credit cards can be used to finance vendor purchases until the CCC is complete. It should be noted that we recommend extreme caution when it comes to using lines of credit and business credit cards. It is important to make sure that when cash is received for the goods or services provided that the payment is made to ensure that the debt does not spiral out of control.
- Invest in the Business – Cash flows can be improved by investing in your business. Investing in your business can boost sales which can help to improve cash flows. This can be done in a variety of ways including training for staff, investment in infrastructure, advertising campaigns and customer rewards programs. All of these tactics can have a positive effect on cash flows.
Please be advised that these tips are general in nature and may not apply to all types of businesses in all markets. Furthermore, there could be other strategies that fit a business’s needs that are not mentioned above. There is no one right way to improve cash flows, and it is unlikely that just one strategy will need to be employed. Improving cash flows will require an overall change in the approach to how a business is managed, but the effect on cash flow must be considered when making virtually all business decisions.