Cash Flow Forecasting … Show me the money!

Cash Flow Cycle

There’s no getting around it. Businesses run on cash.  The current economic situation makes it painfully clear: when the cash flow stops, 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 forewarned 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 (COD), you’d have no cash flow 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 book-keeper 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 last 12 months of sales from the income statement. Use this simple formula to find the average number of days that it takes you to collect money from customers.  This is called “Days Sales Outstanding”, or DSO.

 

Accounts Receivable Today
—————————————————— X 365 = DSO
Total Sales During The Last 12 Months

 

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 total cost for everything you bought during the last 12 months. Using the formula below, you can easily find the number of days you take to pay your bills, which we call “Days Payables Outstanding” or DPO.

 

Accounts Payable Today
—————————————————— X 365 = DPO
Total Expenses During Last 12 Months

 

[SHORTCUT: You don’t have to use a 12 month or 365 day period for these things.  For a 1-month calculation, divide by the totals from the last 30 days, then multiply by 30 days! The result will be the same.]

Look Into the Future
If you can float your bills longer than your customers do (DPO > DSO), cash will actually accumulate in your business. If your customers are dragging their feet (DSO > DPO), however, cash is flowing out the door. The bigger the difference (DPO-DSO), the faster the cash is flowing – in or out. 

So how bad is it? The difference or “float” (DPO – DSO = Float) is the number of days of sales (expressed in dollars) 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 the checking account (the equation is: Sales / 365 * 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.

Dedicated to your (cash) profits,
David

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