Understanding the Peaks and Troughs of a Cash Flow Cycle

While it would be nice to know we could rely on our businesses to be flourishing money trees, there are those times when they bear no fruit. Despite our consistent efforts to produce, there are times when no money comes in. That’s why, just like a tree, a business needs to bring cash in and let cash out in order to survive and grow strong. That movement of cash coming in and going out is known as your business’ cash flow.

As a business owner, you will realize that cash flow is cyclical. Cash flow is one of the many factors involved that influences the results of your company. In fact, cash flow is one of the most important aspects to understand in order to sustain your business.

The Cash Flow Cycle

As the illustration from Dun and Bradstreet illustrates below, there are many steps in the cash flow cycle.

Cash is always moving out or in. Money is typically paid out for many reasons, including paying your staff, covering overhead expenses, and purchasing equipment and supplies. These expenses are referred to as “accounts payable” transactions. Accounts payable may feel like a burden, but they’re actually helping you to fuel the growth of your business, whether that’s selling a product or a service. When you make that sale, you send an invoice, also known as an “accounts receivable” transaction.

Ideally, your accounts receivable will replace what was spent satisfying your accounts payable, and ideally provide more value to create the profits you need to start this cycle over again.

Why Time Is of the Essence

The cash flow cycle is similar across many businesses, but what varies among them is the amount of time between cash outflow and cash inflow. Every business experiences a different length of time, thereby affecting how their business operates.

For example, a long cash flow cycle might be caused by a high days sales outstanding (DSO) number with little cash on-hand with which to pay bills. That lack of readily available cash can even lead to the failure of a business, because the cash flow cycle is so long that the business runs out of money and isn’t able to obtain the resources to create something for the target audience to buy.

This is what makes business owners panic, and it’s understandable. But it’s also important to remain calm and realize that this happens in all businesses. Customers, for their own reasons, may pay sooner or much later. Ideally, you will have a combination of customers, providing you with multiple cash flow cycles to manage.

So, wrapping it all up, the faster the cycle occurs, the faster you get paid. The faster you get paid, the faster you turn a profit that you can reinvest into the business. Let’s talk about ways of getting you paid faster.

Controlling the Cash Flow Cycle

While you might think turning to a loan, line of credit or invoice factoring to deal with cash flow woes might be a good solution, they can only provide short-term relief. A permanent solution requires looking at your entire business. To gain an understanding of the cash flow cycle, including the peaks of timely payments and the troughs of non-payments, takes time and usually some training.

Start by looking at invoicing data compiled by your financial software or other source to find the causes for any cash flow gaps. More specifically, you need to find a way to get paid more quickly while being able to satisfy your own bills in a timely fashion. This starts with including the right terminology and policies on your outgoing invoices.

Here are some suggestions to influence your customers’ payment timing:

• Provide clear and specific payment terms. Your invoice template should include space for payment terms so that you always clearly list any payment penalties or fees associated with not paying within the stated time period.
• Offer a discount for early repayment. For example, if a customer pays an invoice within the first 10 days of a net 30 invoice, give them a 2% discount. Include this discount as part of your invoice terms.
• Stay in constant contact with those customers that are behind on their payments. This way, they know you are serious about being paid. Don’t hesitate to alert them to their past due status.
• Offer convenient ways for your customers to pay. This should include online invoicing using a payment system that allows customers to receive, review and pay their invoices from anywhere on any type of device. The easier you make it for them, the more inclined they are to pay it immediately.

Customer invoices, however, are just one part of a two-pronged approach to controlling your cash flow cycle. Maximizing peaks and minimizing troughs requires you to also have a plan of attack for cash outflows. Here are some tactics to consider:

• Renegotiate payment terms or due dates. This can help spread out your accounts payables to a manageable schedule.
• Ask for a discount on the invoice total for paying early, like you should be doing for your own customers.
• Establish a payables management system to track due dates so you can know when each one of your “payment due” invoices arrives, then pay it as close to that due date as possible.

Stay Calm

That’s really what it all comes down to. Stay calm, stay attentive and let the cash flow. If you follow these tips, your cash flow can remain steady. Even if your business isn’t bursting at the seams with money due to some unforeseen occurrence or clients that just are not paying, the strategies above can ensure that your business’ account stays healthy and able to help you navigate those (hopefully) rare cash droughts.