“My business is profitable, but I never seem to have any cash.” Does this seem to happen in your business? Typical financial statements are usually kept on the accrual basis, so when you ship your product you record revenue, when you incur an expense, you recorded it; and when your suppliers ship your products under the common terms “FOB shipping point”, you record the asset and liability.
But the recognition of revenues and expenses does not always correlate with the movement of cash. Suppliers usually give you at least 30 days to pay. Employees are usually paid in 1 to 2 week cycles. There is always lag time between when your products or materials enter your business, and when finished products are shipped to your customers. And lastly, even though customers are required to pay in 30 days, without proper financial management, most pay in 60 days or even longer. This creates the gap between inflows and outflows of cash, which is why you are profitable, yet never seem to have any cash.
This scenario is why banks created working capital lines of credit. This tool helps you bridge the gap between your inflows and outflows of cash. Although it is easy to draw on your line of credit to pay your suppliers and employees, it does create extra expense for your business, and your lender does expect you to pay off your balance at least once every 12-month cycle. Reliance on your line of credit to cover your cash shortfalls is really a Band-Aid to a bigger problem related to your stretched out cash cycle.
All elements of your cash cycle should be seriously looked into, including opportunities with your supplier terms, but usually the biggest opportunity lies in proper management of your customer payments. Proper professional management of your accounts receivable may allow you to pull in 15 to 30 days of revenue into your bank account. This will allow you to reduce your reliance on your bank line of credit, reduce your interest expense, and give you peace of mind to help you sleep at night.