28 Apr, 2020
In the previous article, we highlighted why cash flow is crucial to business survival and success. Today we look at what drives your business's cash flow.
There are seven key financial drivers for cash flow. These drivers are available in the Goalseek analysis and include revenue volume, price, cost of goods, expenses, accounts receivable days, inventory days, and accounts payable days. Adjusting each of these drivers enables business managers to control the availability of cash in their business.
Drivers of working capital
In this post, we focus on working capital drivers and how you can monitor these using Fathom. Successful cash management requires monitoring all the elements of the working capital cycle, which includes your Account Receivable days, Accounts Payable days and Inventory days. These metrics are calculated in Fathom and can be tracked using trend charts.
Here is an example single-page report layout which tracks these key numbers:
Tip. Monitoring the period by period changes in these key drivers is often more important than the actual result value for the metric. For example, if Accounts Receivable Days increase by 5 days, then this may signal concerns which have a negative impact on Cash Flow.
Cash Conversion Cycle
As explored in the recent Know your numbers blog post, the ‘Cash Conversion Cycle’ is a useful single metric for measuring all the elements of the working capital cycle. It is a measure of the time that working capital is tied up in the operating cycle of the business. It measures the length of time between purchase of raw materials and the collection of accounts receivable from customers. In other words, it's the time between outlay of cash and cash recovery. In the current challenging trading environment, controlling the time that working capital is tied up in the business could mean the difference between business success and failure.
Let’s consider each of these drivers separately:
Accounts Receivable Days
Accounts Receivable Days is a measure of how long it takes for the business to collect cash from customers. A shorter time to collect from debtors will have a positive impact on Cash Flow. In times of economic downturn, it may be worth evaluating the credit worthiness of all incoming orders, and determine your client’s ability to pay. You may choose to take a deposit, or put stricter payment terms on invoices moving forward.
Accounts Payable Days
Next, take a look at your Accounts Payable days to see how long it takes for the business to pay its creditors. It may be beneficial to explore if you can negotiate lengthier payment terms with suppliers. However, it is important to consider that it is a challenging time for your suppliers also. While delaying payment will have a positive impact on Cash Flow, an excessive lengthening in this ratio could threaten continuity of service from your suppliers.
The final pillar of this working capital analysis is looking at Inventory Days. For product-based businesses, inventory days is a measure of the efficiency of the inventory control and turnover. You will want to monitor these, as an increase in inventory days means a slowing in the turnover of any stock or inventory the business is holding.
Tip. For services-based businesses, you can track WIP days as part of your Cash Conversion Cycle. This is a measure of the number of days, on average, that jobs are in progress prior to invoicing.
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Written by Allanah Miller
Allanah is a qualified CPA, and Partner Consultant at Fathom. Before working at Fathom, Allanah studied at UCLA before working with PwC for 3 years as a Senior Tax Associate.