Sin number 7 - Not knowing your operating cash cycle.
By Greg Carroll
The operating cash cycle is the time difference between when a business must pay money out for goods or materials, processing those goods or materials, selling the finished product or service, and actually getting paid for delivering the finished goods or services. Understanding this cycle will give you a good idea of how much cash you need to carry in your business at any point in time.
Looking at a very simple example. Let's assume you were a distributor. Your sales process would be something like this:
- Purchase stock
- Promote stock for sale
- Pay supplier for stock
- Sell stock
- Pay for promotion of stock
- Payment for sales received
Straight away you can see that you have had to pay money out for both the purchase of stock and the promotion of stock before you have received any money back in. You also have to fund your businesses operating expenses during this period. So if your sales process took 60 days from start to finish you would need to be holding sufficient cash to cover the purchase of stock, payment of promotion costs, plus two months operating expenses.
Remember back in the example with ABC, while they were making a profit they did not have sufficient cash to cover their expenses while they were waiting to get paid.
So understanding this cycle is going to give you a better idea of how much cash you need to be carrying at any point in time. If your cash level slips below this figure then this is your first early warning sign that there could be trouble ahead. Remember in the real world your debtors do not always pay on time, so this figure is a bare minimum.
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