Cashflow – Symptom & Cause

• Symptom – an indication of the existence of something, especially of an undesirable situation
• Cause – a person or thing that gives rise to an action, phenomenon, or condition
• Cashflow – the total amount of money being transferred into and out of a business, especially as affecting liquidity

One of the main reasons I get asked about raising finance for – cashflow. The answer is that financing your cashflow is addressing the symptom, unless you address the cause then you will be borrowing again very soon.

Every time you borrow to fund cashflow it gets more difficult, more expensive and you have less options. Ultimately, without addressing the cause your cash will run out.

Addressing Cashflow Cause

Don’t assume that cashflow problems are down to you not being paid, they might be but by looking only at the obvious you often miss the real problem.

Every business is different but there are some standard things you can do to identify cashflow problems in a methodical manner.

Some of the best methods to use are;

• Debtor Days
• Creditor Days
• Stock Days

You don’t need any accountancy skills to look at these, so long as you have a bookkeeping system then you can measure these yourself. If you don’t have a bookkeeping system in place then we may have found the first cause (for recommendations on systems to use speak to your accountant but I like Xero or Kashflow).

How to work out your Debtor Days, Creditor Days and Stock Days is shown at the end of the post, in the meantime I want to show why it is important to look at these ratios.

Why Use These Ratios

Debtor days will show you how long it is taking for you to get paid. Don’t worry so much about the time but about how that time is changing. It is about the trend. If the time is getting longer then jump on it, chase invoices, use the phone and make sure you keep in charge of what you are owed. You are not your client’s overdraft facility for them to use whenever they want.

Creditor days is about how long it takes you to pay your bills. If cashflow is tight then make sure you are using the terms your supplier gave you. Watch out for this ratio getting longer, while a longer figure will help your cashflow your suppliers will eventually run out of patience and having no terms is much much worse.

Stock days is interesting. This will show how long it takes to turn your stock into sales. For many businesses their cash is tied up in stock. Look at what you are holding, see what is still sellable, discount what is not being sold, cash is always better than perished stock. Sometimes cash is more important than profit.

Take all these ratios, look at the figures and compare them to what you thought they would be. If things are out of kilter then you may have found your cause.

The Cashflow Problem From Success

Most businesses think cashflow problems are a result of poor trading. Often it is good trading that causes a shortage of cash, however it is just as dangerous.

With cashflow, make sure you know why you are needing to finance it. Growth has it’s own challenges, managing cashflow through growth requires planning and strategy. Use the ratios above and take action.

If you need to finance growth cashflow then fine, but make sure you finance enough of it. Look ahead, don’t finance your cashflow need now, finance your cashflow demand 12 months into the future, plan ahead as far as you can.

Few lenders want to finance your cashflow need as of today. They will look at future need more happily as it shows you are financing having looked at the cause and are not trying to plaster over the symptom.

By Dave Farmer

Dave Farmer is founder of the multi award winning Lime Consultancy, a business lending specialist based in Sussex.

Any comments about this post? Add them above or drop us a line.

Working Out The Ratios

Debtor Days – Trade Debtor / Sales * 365

Creditor Days – Trade Creditors / Cost of Sale Purchases * 365

Stock Days – Cost of Goods Sold / Stock * 365

These are all based on using your year end figures to work things out. If using based on monthly accounts then change 365 to 30 etc. Any queries then please get in touch.