Often businesses with the right product, energetic founder, enthusiastic team, and a solid marketing strategy still struggle to make it.
One of the key reasons is poor cash flow management. In more technical terms, a long working capital cycle. That is the time between paying your suppliers and finally collecting cash from your customers.
Let me explain how,
If you receive cash from your customers on 45‑day credit terms, but you have to pay your suppliers on 30‑day terms, you need to fund that 15‑day gap. If you use short‑term finance to plug that gap, the interest cost eats into your margin.
If your business also needs to hold inventory for 60 days, you wait 60 days before you can even sell it. After that, you still wait another 45 days to get paid, while your suppliers are expecting payment in 30 days, if not in advance. You turn to financing to bridge the gap, pay interest, become more vulnerable in any downturn, and see your margins steadily erode.
On top of that, there are often delays in payment of invoices. You may think that a delay of a week or two for an invoice payment would not harm you as much. Think again!
Let’s try to understand this by two examples,
Company A invests £100,000 on day 1. It buys goods worth £100,000 and pays to the vendor right away. Now let’s say average inventory days are 60 days. It takes 60 days for the company to sell these goods. Margin is 25%. If the company has a 15 day credit term with its debtors, the company will receive £125,000 after 15 days. In this example, the company was sitting without cash for the whole of inventory holding period and then for the credit term. That’s 75 days for the company to get it money back which can then reinvest in the business again.
Company B invests £100,000 on day 1. It buys goods worth £100,000 and agrees with a vendor for a payment term of 30 days. Now let’s say average inventory days are 25 days. Which means, it takes 25 days for the company to sell these goods. Margin is 25%. If the company has a 5 day credit term with its debtors, the company will receive £125,000 after 5 days. In this example, the company paid £100,000 to supplier and received £125,000 from customer on day 30.
Company B manages to finish the cycle in 30 days. The shorter your working capital cycle is, the faster you can reinvest money in the business. If we keep other things aside, Company B will be able to reinvest capital about 2.5 times faster compared to company A which will directly contribute to its growth.
I have simplified these examples to demonstrate the point. In reality, there are more layers to it. Once you understand how it impacts your growth, you may approach invoicing and collections more carefully.
I will be happy to chat to discuss your specific situation and how that can be improved.
Experienced finance professional with over 10 years of expertise in Management Consulting, Accounting, and Auditing. During my time at Deloitte, I led complex statutory audits, provided IFRS…
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