Keep Tabs on Cash Flow

There’s no getting around it. Businesses run on cash. When the cash goes, the business stops.

The amazing thing is that every company has the power to both predict and avert sales-related cash-flow problems. A few numbers from your balance sheet and income statement are all you need to be warned of an impending problem.

Let’s say you run a fine-wine distribution business–the kind that sells by the case to restaurants and retailers. If all your customers paid cash on delivery, you’d have no problems. But these days, more and more customers are asking to pay on terms–and some are already falling behind on payments. How long can you keep that up?

Obviously, things are going in the wrong direction, but don’t panic. Instead, grab your bookkeeper and a calculator to look into your cash-flow future.

The here and now

The calculation is quick and painless. Start with accounts receivable from the balance sheet (the total dollar value owed to you by customers) and the past 12 months of sales from the income statement. Now do some math:

Accounts Receivable / Twelve Months total Sales * 365 = DSO

Use this simple formula to find the average number of days it takes you to collect money from customers. This is called “days sales outstanding,” or DSO.

That’s half the story. Now look at how quickly you pay your bills. Start with the total amount of accounts payable (the total dollar value you owe to vendors) and the 12-month Total Cost of Goods (COGS) and Expenses from an income statement. We’ll use a similar formula:

Accounts Payable / Twelve Months of COGS and Expenses * 365 = DSO

Using this formula, you can easily find the number of days you take to pay your bills, which we call “days payables outstanding,” or DPO.

Look into the future

If you can float your bills longer than your customers do (DPO is greater than DSO), cash will actually accumulate in your business. However, if your customers are dragging their feet (DSO is greater than DPO), cash is going out the door. The bigger the difference (DPO minus DSO), the faster the cash is flowing–in or out.

So how bad is it? The difference, or “float,” is the number of days of sales (in cash) that are flowing in or out of your business each year. So a $1 million business with just one week of negative float will watch nearly $20,000 evaporate from its checking account. (The equation is: sales/365 X float.) Worse, this entire drop can happen in just one payables cycle.

Fortunately, there are two ways to put a cork in a negative cash flow: collect more quickly from customers or get better payment terms from vendors. Doing either can plug the gap. Doing both will keep your cash flowing for many vintages to come.