A vital component to Financial Mastery is understanding and managing the cash gap
The number one reason why perfectly healthy growing businesses go bust is their failure to determine and make adjustments to their cash gap. The example I’m gonna share with you today is with the manufacturing business. Imagine that we manufacture and sell widgets.
On Day 0, the raw materials that we make the widgets from, some sheet metal, arrive on site and go into the warehouse. Our supplier gives us 30-days terms, and therefore on Day 30, we pay. That means that on Day 30, the money has now left the business.
The sheet metal sits in the warehouse, then gets taken to the factory to be manufactured into widgets, and then the widgets are put in the shop. Then on Day 60, somebody comes into the shop and says he’ll buy those widgets.
So on Day 60, the goods are dispatched, and because we’re such lovely people to do business with, we ended up giving the customer 60-days terms. Therefore, the money from the sale of those widgets comes back to us on Day 120.
Remember, the money left on Day 30. In this example, therefore, this means that for 90 entire days, the money was out of our business.
I believe money is oxygen. Without it, we cannot survive in business. A 90-day cash gap is not a pretty good situation. But here’s what I’ll tell you for nothing: that gap is actually quite conservative if you compare it with an average business.
To resolve this, our first objective is to work out what our cash gap is. Even if you’re in the service sector, this still matters because you would still need to pay wages out.
How do we close our cash gap? How do we adjust it from the left hand side and push it to the right? The most common way is to re-negotiate terms with suppliers. What’s the worst that could happen if we ask? Someone could say no, but if you don’t ask, you’ll never going to find out.
What about shortening it from the right, bringing it towards the left? Well, the biggest way to achieve that is through debtors —people who owe us money. And this is one of the most sensitive areas that we need to come to terms with. We need a systematic debt collection process that is followed robustly every single day.
Here’s a fact: people pay people who contact them the most. If you don’t bother getting in touch with people who owe you money because you’re afraid of offending them — or whatever reason you may have — you’re not going to get paid on time, or at all.
As a Business Coach, one of my tasks is to help you determine your cash gap, and figure out how to close it from both sides.