If you send out invoices and wait for payments, this article can help you to improve your cash flow by reducing your ‘days to cash.’ Days to cash measures how long it takes you to convert your costs and inputs such as employee time, inventory, products and services, into cash.
Cash flow is like the fuel in your car: The faster you drive, the more you burn. The same is true in business. Yes, even highly profitable companies can run out of cash.
Most businesses don’t track or significantly under-estimate their days to cash and the following example will help you to measure and improve this important metric.
Improving your days to cash will provide more fuel for future growth, reduce the debt you need, increase your profits, enhance your business value and reduce the time and stress associated with juggling cash flow.
An Example: Turbo Commercial Painters
It’s challenging to explain financial ratios using words, so I am going to use an example with a service business called Turbo Commercial Painters that paints industrial equipment and buildings.
Let’s say you’ve given the customer a quote on August 15th for $18,000 plus materials to paint their shop interior and the customer accepts so you book the job for September 1st.
- You start on the first as promised, the job goes well, you juggle a couple of other jobs at the same time, and you finish this job on September 15th.
- It’s a fixed price job but you’re waiting for your supplier’s invoice for the special paint.
- On September 29th you receive your supplier’s paint invoice for $2,000 but you’re busy with month end procedures.
- You send out your invoice for $20,000 on October 10th.
- Your customer has 30 days from date of invoice to pay so your customer sends you a cheque for $20,000 on November 10th.
- November 11th is a holiday, it’s a long weekend, and you finally receive and deposit the cheque on November 15th.
- Days to cash: from September 1 to November 15 = 74 days. Ouch!
Here is a better way:
- Upon customer acceptance, you receive a deposit for 50% or $10,000 on August 16th as you estimated the project to cost $20,000 (including materials).
- Days to cash = negative 15 days, as you haven’t started the work yet.
- You do the work and finish on September 15th.
- Instead of waiting for your suppliers invoice, you phone the supplier immediately and get the price of $2,000.
- You issue your final invoice for the remaining balance of $10,000 on September 16th.
- You give your customer terms of 2%/10 days, net 30.
- Assuming your customer takes the 2% discount, they send you $9,800 ($10,000 – $200 discount = $9,800) by September 26th. Days to cash for this payment = 26 days.
- Average days to cash = negative 15 + 26 = 11 days.
- If your customer takes the full 30 days to make the final payment, and add a couple for processing and delays up to October 19, days to cash for this payment = 50. Average days to cash = 25 days. This is still a 49 day improvement over 74 days.
In the example above, the company with 11 days to cash has more than six times the growth capacity of the company with 74 days to cash. The difference is 63 days or two months.
Look at your income statement. If you had two months sales sitting in cash instead of accounts receivable, how fast could you grow?
Not only will this decrease your borrowing costs and provide more resources for growth, it will greatly reduce your stress and the time wasted juggling payables and phoning customers in order to manage your cash flow. The best companies take control so they know how much fuel they have in the tank and how fast they can drive.
You can dramatically improve your days to cash by:
- Deposits-obtaining a deposit at the time of order.
- Frequency-invoicing frequently at convenient times for you, upon milestone or completion, and definitely more often than monthly.
- Speed-invoicing quickly after the provision of services. Don’t wait for the freight bill! Make an educated estimate and send it out.
- Electrons-Setting up your customers for automatic payments or electronic payments.
- Visa/MasterCard/AmEx-Accepting credit cards instead of issuing invoices and waiting for snail-mail cheque payments.
- 2%-Giving discounts for prompt payment within ten days of invoice date.
Which steps can you take immediately to improve your days to cash?
Copyright 2011 Phil Symchych. All rights reserved.