In this episode:
Everyday business owners are asking us where their cash has gone. More often than not, they ask about their debtors and how to get them to pay more promptly. But cash flow and getting your hands on your cash is more complicated than just debtors. On this episode we explain the cash flow cycle.
Riann Umaga-Marshall: Hi, I’m Riann Umaga-Marshall.
Hamish Mexted: And I’m Hamish Mexted.
Riann Umaga– Marshall: And welcome to Business Made Easy. Every day business owners are asking us where their cash has gone. More often than not, they ask about their debtors and how to get them to pay more promptly. But cash flow and getting your hands on your cash is more complicated than just debtors.
Hamish Mexted: So we had a customer come to us earlier in the week and they were starting up a new brewery business, so they were crafting their own beer and then selling that through local bars and restaurants. Their immediate question was making sure that they got paid really quickly by the bars, because they were worried that if one of their customers went under, they wouldn’t get paid, which would then leave them out of pocket.
But the more and more we started to delve into what they were asking, it appeared that their working capital and their cash flow cycle was much more important than just getting paid by their debtors. So on day one they would be coming together as shareholders and having a chunk of cash that they would then invest into their premise, their equipment, their first couple of months’ rent payments, and a whole bunch of other overheads that they needed to meet, to get their new business off the ground.
They’ll then have to go ahead and buy some ingredients, so yeast and hops and a whole bunch of other stuff, which they would often need to pay for up front, because they’re a new business they didn’t have any credit history and their suppliers were really reluctant to give them longer payment terms. They’ll then take those ingredients and turn them into beer, through the brewing process, which again would take more time. So as we go along, more and more of their cash is held up for a longer and longer period. Now this is even before we get to the stage of them marketing their product, and then selling their product, and then them eventually getting paid.
So, their first question started with debtors, but it was so much more detailed than that. Simply because, that the debtor is the last stage of the process. Everything else takes time. The debtors is the small component, so what’s been really important for them to get their head around is how long their cash flow cycle, or how long their working capital cycle really is. It’s not just sales and not just collecting debtors, it’s getting the job done, or getting the brewing done as quickly as possible, getting it sold as quickly as possible, and from there collecting the money as quickly as possible. Once they do get paid though, it becomes a question of what they do with the money.
So, if the customer has paid, you’ve obviously got some GST and other obligations to meet, but then you’re left with an amount of money that you can decide to reinvest in your business, so that could be more plant and equipment, you might have some debt to pay off, you might have a shareholder who would like to take a dividend out. But you’ve also got the key question of how much you then reinvest back into more ingredients in this case, or if you’re a services business, more time from your employees.
So, the more you can invest back into new ingredients, or more time, or whatever it is for you, the quicker you then convert that back into cash again. Which generates more profit that you can then use to reinvest in your business, once more. Ultimately though, this is a game of getting the cash spinning, as opposed to simply getting more sales for the sake of getting more sales. So, as the saying goes, turnover is vanity, profit is sanity. Most people are chasing sales for the sake of chasing sales. This conversation is more of getting your money spinning, rather than chasing another dollar, because ultimately it’s the profit from that other dollar which is what will help you sleep easy at night as a business owner, with more cash flow to work with.
Riann Umaga-Marshall: So, if you take that cycle that Hamish just went through, and measure it in days, then look at how you can get the cash moving through those phases quicker, that’s the key. Not increasing sales for the sake of it. Increasing sales can just mean more cash tied up in your various phases, so more cash flow issues than it solves. If you fix it on the smaller scale, than when sales do grow, your spin is faster and money will move, hopefully more into your bank than out.
Hamish Mexted: On that, we’ve had another customer recently who was able to get their jobs completed on average ten days quicker than they were previously. Now this customer is in the web design/graphic design space and they’ve been able to shorten how long it takes them to do jobs, simply by engaging with their customers differently. So they get more information up front and they ask the customer fewer questions along the way. So by changing how they engage, they can get their jobs done quicker, which means they get their bills out the door faster and all in all, their working capital cycle or their cash flow cycle, gets shorter.
Riann Umga-Marshall: That’s all we’ve got time for today. For more info on what we’ve covered, check out the podcast section of convexhub.co.nz and go to episode two. There you can download a worksheet on the working capital cycle. Next time we’ll step you through the impact that measuring your working capital cycle can have on your business. In the meantime, if there is anything you’d like us to cover in future lessons, then reach out to us via the website or send us a message on LinkedIn. Thanks for tuning in!