Important Cash Flow Vocabulary

These words put some people off because they sound like accounting and financial analysis. But they’re good terms to know, especially if you’re running a business. This is important cash flow vocabulary.

  • Cash in business planning and financial projections is not coins and bills. It’s liquidity, money in checking and other instantly available accounts; money you have and you can spend.
  • Cash sales include sales by real cash, bills and coins; plus sales paid by check or credit cards. In financial projections, sales are either cash or on credit (below).
  • Sales on credit isn’t about credit cards, but rather the common practice of businesses selling to other businesses, and sometimes businesses selling to consumers. It’s also called sales on account. It refers to when a business delivers the goods and services to a business customer along with an invoice that will be paid later, not immediately. The amount involved is considered Accounts Receivable for the seller, and Accounts Payable for the buyer.
  • simple collection days formulaCollection days is how many days, on average, a business waits for customers to pay their invoices. The unit is days, so 30 is about a month and 90 about three months. Accountants and analysts calculate average collection days for a business by multiplying 365 times times the average receivables balance and dividing that by annual sales on credit. And this is often called Collection Period.
  • Receivables is short for Accounts Receivable, which is money owed to a business. It may include some outstanding loans to employees, for example, and some other items; but the bulk of Accounts Receivable, and analysis of Accounts Receivable, is amount owed to a business by customers who haven’t paid yet.
  • Accounts Payable is money a business owes. When your business customers haven’t paid you, what is accounts receivable to you is accounts payable to them.
  • Payment days is how many days, on average, a business waits before paying its invoices. The unit is days, so 30 is about a month and 90 is about three months. In many ways it’s just the other side of the coin of collection days. If I’m your customer, then my payment days figure into your collection days. However, the formulas for payment days are harder to deal with than for collection days, because standard accounting keeps much closer track of sales on credit than new entries to accounts payable, and new accounts payable is not an obvious concept. So I’m defining it with this illustration:new-payablespayment days formulaTotal New Payables for a year would be the sum of all the monthly entries in the bottom row of the illustration above. So once you get that number for total new payables, you can then calculate payment days with a formula similar to the one for collection days: multiply the average payables balance by 365, and divide that product by the total new payables for the year.
  • Inventory is goods and materials that you’ve purchased and you keep until you sell it to customers. That could be materials you’re going to assemble into something, or products you’re going to sell. Inventory is an asset. It doesn’t become a cost until you sell it. Therefore it doesn’t show up on the profit and loss statement until you sell it. But you may have already paid for it by the time you sell it.
  • inventory turnover formulaInventory Turnover is a measurement of how much inventory you have on hand. Inventory on hand tends to be a drain on working capital because you pay for it before you sell it. The higher the turnover, the less inventory is sitting in your business waiting to get sold, and the better for cash flow. Analysts talk about “turns,” so that if your average inventory is equivalent to a year’s worth of sales, that’s one turn. Businesses aim for 10, 20, or more turns. Calculate inventory turnover by dividing your cost of goods sold by your average inventory balance.

Word of warning:

Unfortunately, even with financial analysts and accountants as literal as they are, with their insistence on things being exactly correct, there are different ways to calculate some of these numbers. And, to make matters worse, many of them calculate a number one way and don’t realize that there is more than one way. For example:

  • Many of them use the number 360 in these calculations instead of 365
  • Many of them use ending balance for these calculations instead of average balance.
  • Many of them calculate payment days using cost of goods sold instead of new payables.

And other discrepancies will turn up. Don’t take them too seriously when they say that one of these calculations are wrong. It’s just different.

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