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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