All businesses go through periodic cash shortages. Owners commonly think they need to get out and sell more during these times. However, this approach can occasionally increase money troubles over the short run. Why is that? It’s because of a notion called the “cash gap.” By understanding and applying this concept, you will be able to generate supplementary cash to meet working capital needs. Here’s how.
Focus on the balance sheet
The cash gap is a function of the timing discrepancy between 1) when companies order materials and pay suppliers, and 2) when they receive payment from their customers. This discrepancy can result in cash shortages when the business is lacking spare funds, is unable to qualify for increased bank financing or is not keen on using a line of credit. When cash gaps are financed by banks, bear in mind that this will bring about interest charges, as well.
Boosting sales typically won’t solve the problem when funds are low, since selling more generally causes the cash gap to increase. This occurs because new sales costs have to be fronted by the company to fill the orders; they then await payment from customers after the invoices have been sent out. This notion explains why high growth companies and start-ups are apt to undergo cash shortages.
Finding hidden treasures
When financing the cash gap, you will save thousands of dollars (over the course of a year) that would otherwise have been paid in interest — simply by cutting a day or two off the gap. Reducing the cash gap calls for you to zero in on its underlying variables:
Inventory. Decreasing your investment in inventory can happen in several ways. One idea is to look for slow-moving items around the warehouse. You can then take items back for credit, swap the objects with another competitor or supplier, or peddle them for scrap.
Another method would be to modify your company’s purchasing guidelines. For instance, certain parts and materials suppliers might consent to marked-down consignment or bill-and-ship agreements in exchange for exclusive or long-term contracts.
Receivables. The quicker your business can get paid, the shorter your cash gap will be. Promote faster payments by issuing past-due reminder letters to customers and following up with phone calls. Assess company invoicing techniques to reduce the days in receivables. Poor communication among sales, production and billing staff can create invoicing delays.
Payables. Think of trade payables as a form of interest-free financing. Be mindful that a company can only prolong its payables so far. If you delay paying, your company may give up early-bird discounts or encounter less favorable treatment from suppliers, like higher rates, slower delivery or cash-on-delivery terms. Late payments will also hurt a company’s credit rating, along with its reputation amidst eligible suppliers.
Put it to work for you
The cash gap can be a useful management tool because it uncovers buried treasure in your balance sheet. The benefits of a smaller cash gap include running into fewer cash shortages and not having to depend as much on bank financing. Contact us at 949-860-9902 or click here for help gauging your cash gap and utilizing it to handle working capital more effectively.