Assess your cash flow risk with this simple method here. Your business might not have the factors that make cash flow so different from profits. Maybe managing sales and expenses is enough for your business. It depends on the specific factors here.
| Item | Details | |
|---|---|---|
| 1. | Product Inventory | Give yourself 1 point if you deal with product inventory you have to buy and pay for before you can sell it. Add another point for each month of average inventory |
| 2. | Sales on Credit | 1 point if you have to wait for customers to pay invoices (instead of collecting all in cash, check, or credit card when you make the sale of deliver the service.) Add an additional point for every month beyond one that you wait, on average, for customers to pay. |
| 3. | Deposits in advance | If you added a point for #2 above, subtract 1/2 point for having customers pay significant (35% or more) deposits up front. |
| 4. | Other Spending | Add another point if you have to pay significant principle payments on debts, or purchase significant assets (equipment, vehicles, etc.) |
| 5. | Accounts payable | Subtract 1/2 point if you pay expenses by collecting invoices from vendors and waiting a month or more before paying. |
What the cash flow risk assessment means
If you scored less than one with this cash flow risk assessment, heave a sigh of relief and watch your sales, cost of sales, and expenses very carefully. You don’t have to calculate cash flow as a separate exercise. Develop and manage projections of sales, cost of sales, operating expenses, and other spending including repayment of debt and purchase of assets. Put your sales, costs, expenses, and other spending into a worksheet showing your projections for the next 12 months. And maybe, just to be sure, you continue reading with the next section on cash traps, and the one after that, showing a cash example.
If you assess your cash flow risk as 1 or more on this cash flow risk assement, you might still read the next two sections just to be sure, but face it, you can’t afford not to manage cash flow carefully. Aside from just lean business planning, you need to fully understand and manage cash flow; or have somebody on your team who does. You need the three linked projections covered in Section 5: Profit and Loss, Balance Sheet, and, especially, Projected Cash Flow.
Collection 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.
Total 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 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.