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Recognizing and Understanding the Cash Flow Gap

Guest post by: Stan Prokop

Article Overview: The article discusses how business owners identify gaps in their cash flow cycle.

Recognizing and Understanding the Cash Flow Gap

Fundamentally it seems easy - make or deliver your product and service, collect the money, and start over. Simple, right?

Well, not really, as most business owners quickly recognize. What many business owners and managers fail to recognize is what we will call the ' working capital gap '. Simply speaking it's the amount of time that it takes for a company to produce, sell, and collect on that product or service. During that period inventories and receivables and bank accounts fluctuate greatly, and deficits and surpluses are potentially significant.

Is that a bad thing.? Definitely not. Does it indicate that a company is weak or failing? Most definitely not! Strong business managers can in fact prepare to cover those temporary deficits - if they don't however the firms creditors can withdraw from support, leading to a potential failure.

Let's understand the cash flow cycle a bit more in detail. We will assume a company is in fact producing goods, although many service companies have the same challenge but in a somewhat different manner, given there is not inventory or product per se.

Back to the cash flow cycle then - the company buys raw materials and supplies. Payables are created and inventories mount. Product is produced and sales are made on credit, most normally ' 30 day terms '. (Of course most business owners quickly realize that terms are 30 days but no one pays in 30 days!).

Finally though the receivable is collected and the cycle repeats itself. However the number of days that all of this takes to transpire is of course most commonly known as the ' cash flow gap ', in our working capital cycle.

In a perfect world the company finances it's receivables with the bank, as the cash flow cycle repeats itself over and over again.But if a company relaxes its payment terms, or gives formal extended terms to customers, the time factor is significantly augmented. Companies that have strong financing in place can of course increase sales and profits by offering extended terms to their customers. They can also increase their own profits by using the cash flow financing from their bank to take supplier discounts and negotiate better pricing on materials.

Banks and finance companies are critical in this entire process. If the customer can obtain the right working capital and cash flow financing a proper balance can be achieved in sales, profits, and asset turnaround.

However if a firm cannot properly finance the working capital assets the firm experiences serious financial challenges.

In summary, business owners need to understand the ebbs and flows of the cash flow cycle as it relates specifically to their business and industry. Banks and other private finance firms are critical to the working capital cycle. Customers must have the support of the bank with respect to proper credit lines. The bank of course needs to be convinced that the customer understands it's cash flow gap, and can manage properly through the working capital cycle. If a firm cannot achieve proper bank support re their working capital requirements other alternatives will need to be assessed.

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Article Tags: cash flow gap, identifying cash flow problems



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