Why Cash Is Tricky For Some Operators?

In today’s Coffee…

  • Understanding the Cash Components

  • 650 words, total reading time under 3 minutes

We talk a lot about making more profit and it is important because it ultimately drives the cash in the business long term. But, below the rich surface of profit there are several levers for managing cash.

Look at it like two forces of cash; money you get and money you loan to the business. Money from clients, vendors and credit card companies that you use (liabilities) and money you loan (sometimes unknowingly to the business) thru accounts receivables and inventory. Some think of this as working capital (what the business needs to run and pay bills, etc.). The idea being if you can drive down the amount of money you tie up in the business the more efficient it is for you.

But what are the ideal levels of each of these moving parts: inventory, payables, credit cards, accounts receivables and client deposits for that matter. We have seen enough companies to know what’s possible.

Here are some guidelines based on % of Revenue (trailing 12 months):

  1. Inventory (every effort should be made to be just in time) hence inventories needs to be less than 5% of Revenue. (about 45 days of COGS).

  2. Accounts Receivables (you should be getting advanced payments all along and keeping the final payment to 5% maximum) hence AR needs to be less than 30 days or 8.3% of Revenue.

  3. Payables (this typically is what the vendors provide you in terms) take advantage of all prompt pays hence the Payables need to be less 3% of Revenue; at levels above this, you are probably stringing out your vendors.

  4. Credit Cards (there are membership privileges right?) but the practice of paying off the monthly bill sometimes gets out of control causing interest charges (not good). Keep credit card balances below 1.5% of Revenue; anything above this suggests you are not using the credit cards as you originally intended.

  5. Client Deposits (while not part of working capital per se; it is a zero cost form of financing that you should take advantage of). This is not simply the first deposit only but your terms for all advances before the work is performed play into this. Keep client deposits above 6% (some actually achieved double digits here), and you will avert many cash crunch issues.

So how does this all work together to address the cash problem?

By being lean on inventory and AR, you are reducing the amount of money you are loaning the business. By being responsible with payables and credit cards you are averting longer-term pressure on cash payments. By having a healthy dose of client deposits you put yourself in a position that when profit is at VITAL norms; you accumulate cash and set sail to having 7 digits of consistent free cash in the business.

Let’s look at one example:

Clients’ deposits are at 9% of Revenue Great!

Inventory is at 4% (a just in time or close to it operator)

AR (because you are good at it) is at 6%

Payables (being a good payer and prompt discount taker) is at 2%

Credit Cards are consistently at 1%

So what’s the impact?

You have 10% (6+4) loaned to the business;

You are using other people’s money (9+2+1) 12%;

You are 2% to the GOOD side. It’s not your money yet but in effect other people are providing the working capital for the business.

Of course, you can lean on your vendors and credit cards for more leverage but that’s not our advice.

WHY is this important?

We find that many CI companies are double digits of Revenue to the BAD side (meaning they are loaning or tying up too much of their money in INV/AR or not working client terms in their favor).

Don’t be one of these companies.

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