How to manage a short term cash flow gap

gap in cash flow

How to manage a short term cash flow gap

An unmanaged cash flow gap can cause serious problems and put a business at risk of failure. Through a combination of sound strategy and the right finance product, businesses can take control and manage short-term cash flow gaps, boost growth and optimise their supply chain. Here we take a look at how.

How does a short-term cash flow gap occur?

Cash flow looks at the timing of money changing hands. Whether it’s aligned in a way that means you have money within the business to pay your expenses when you need to.

The number one cause of business failure is poor cash flow. A business can be profitable, yet without adequate cash, it will fail. Without cash, profits are meaningless.

“Balance sheets and income statements are fiction. Cash flow is reality”  – Chris Chocola

A cash flow gap occurs when there is a difference between the timing of cash inflows and outflows. Essentially, when you have already paid out for expenses, yet not received cash back from your customer orders.

Cash flow gaps can soon turn into business failure. Particularly when demands for cash from your employees, suppliers, landlord etc consistently arrive before the cash you’re owed is collected. Indeed, nearly half of UK businesses see cash flow gaps as a potential threat to their business.

It isn’t a lack of money that’s your enemy, but a mismatch of timing.

So how do you manage and close gaps in your cash flow? You first need to optimise the timing of your cash inflows and outflows – your ‘cash flow cycle’.

This can be done in a number of ways.

Optimising your cash flow cycle

Inflow – Managing customers

To minimise the appearance of short term cash flow gaps, a business initially must ensure that cash is coming into the business as quickly as possible.

This means reducing and removing any potential barriers or hindrances to cash inflow.

What does inflow optimisation require? Faster credit decisioning, efficient order fulfilment, shorter terms for customers, faster, more accurate invoicing and robust, efficient collections procedures. Taken together these measures will help to reduce the likelihood of cash flow gaps due to cash inflow.

Outflow – Managing suppliers

Once the money is coming into your business, you need to ensure that it stays long enough to fund its operation.

Traditionally, to close a cash flow gap businesses should seek to negotiate and secure longer payment terms with their suppliers. Many advisors suggest that businesses should always pay on time or extend terms rather than pay early. Unless there is a significant discount offered for early repayment.

Taking advantage of early payment discounts from suppliers usually increases the cash flow gap. This is due to a larger time differential between supplier payment and customer settlement.

However, if you have access to additional working capital and the cost of the working capital is less than the discount you will receive for paying early, it makes financial sense.

More flexible products such as Pay4’s revolving credit facility have improved the cost-effectiveness of early supplier payment. Pay4’s facility injects working capital earlier in the supply chain, bridging the gap between early supplier payment and cash inflow from customer orders.

Managing inventory

It’s also important to not keep excess or unnecessary amounts of stock. This ties up your cash and leaves you more susceptible to potential gaps. Explore efficient stock management operations. Base decisions around improving efficiency. Strike a balance between securing bulk supplier discounts, and keeping your orders smaller which will help avoid cash flow gaps.

Managing overtrading

If you’re a business that is experiencing impressive growth, it’s important not to become a victim of ‘overtrading’ – where you’re selling so much that you run out of cash to buy the resources you need.

For businesses that do not see tempering their growth trajectory as a palatable option, borrowing money to bridge their cash flow gaps is often an important part of a successful financial strategy.

The problem of supply chain conflict

As mentioned above, the main ways to reduce a cash flow gap are to increase your payables period and decrease your collections period.

However, despite these being important elements of business process optimisation, they create fundamental conflicts of interest within the supply chain.

Suppliers look to convert their inventory into cash as quickly as possible. Buyers try to keep cash in their business as long as possible by stretching supplier payment terms. Customers seek better credit terms, and delay payments. This creates essentially a passing around of the cash flow gap between the parties involved, and a win/lose, competitive scenario.

Flexible, growth-focused alternative finance solutions are now available that can facilitate all of these conflicting goals and create a positive effect throughout the entire supply chain.

Smarter borrowing to bridge the gap

Known as ‘supplier payments’ or ‘accounts payable’ finance, they provide working capital at the most important point of the supply chain: paying suppliers. Often used in conjunction with other forms of finance, they do not rely upon the creation of customer invoices. This means that suppliers can be paid before anything is sold on to customers.

They help businesses to manage and overcome the problem of cash flow gaps by injecting cash at precisely the right stage to help fund a seamless trading cycle. Bridging the gap between paying suppliers and receiving money from customers.

Pay4 is one of these solutions. Pay4’s revolving supplier payments facility closes the cash flow gap caused by the differential in timing between settling supplier invoices and receiving customer payments. With up to 120 days credit on the monies borrowed, it is effectively extending the credit period being taken from suppliers, allowing for more breathing space.

With the right flexible, growth-focused supplier payments finance solution it’s possible to use short-term borrowing as a regular, controlled element of a well-rounded financial strategy.

Why is Pay4 the smart option?

Pay4 is simple, flexible, unsecured and growth-focused. By providing working capital for supplier payments early in the cash flow cycle with 120 days credit, it allows growing businesses to pay in advance for items, services and materials without the necessity for asset security, signing over invoice ledgers, customer involvement or punitive non-usage charges.

In short, it is specifically designed for growing business to bridge gaps in their cash flow.

Invoice discounting is less helpful for closing cash flow gaps, as it relies upon customer invoices being raised. This does not help a business when it has up front costs it needs to fund before selling to a customer. Perhaps the most common cause of cash flow gaps.

Because it is unsecured, Pay4 is also designed to able to be used in conjunction with other finance products. Allowing business to tailor their financial strategy for smoothest possible operation.

Business overdrafts on the other hand usually require security, and this can make them unsuitable for certain growing businesses. Those without the assets available to support guarantees will not usually be offered one.

Overdrafts also come with ongoing fees attached, which means that the business has to pay for the credit even if it doesn’t use the facility.

Pay4 has no non-usage charges, allowing it to be used over the short-term to cover cash flow gaps and prepare for peak demand periods. It also allows you to pay your suppliers early, without creating or compounding gaps by charging for non-usage.

Bridging short-term gaps in cash flow.  Funding long term success.

How to manage a short term cash flow gap