What are the early warning signs of business stress?
There are plenty of red flags which go up when the business is under a degree of stress. Lost customers, unsold stock, worn-out equipment, a spike in credit notes, a rash of resignations, and even letters of demand from your trade creditors, your lenders and even the tax office.
But, like the ‘canary in the mine’ you can prevent the situation from deteriorating to this point by paying close attention to two key early warning signs:
Before you take action, use these two simple business metrics to get the numbers you need.
- “Debtor days” tells you how long your customers are holding back your money by being slow to pay your invoices.
- “Net cash flow” tells you how much money flows into and out of your business in a certain period, usually a month.
What are “debtor days”?
“Debtor days” is the average period your customers take to pay, and it’s almost always longer than the payment terms you offered. To work out debtor days, you have to compare the value of invoices outstanding in a particular month with the total value of sales you made on credit last year.
Divide the figure for the month by the figure for the year, and you get a fraction. This tells you what proportion of your annual income was tied up in unpaid invoices in the month.
To find how long your customers kept you waiting, multiply the fraction by 365. You’re effectively working out a fraction of a year, which will be expressed as a number of days.
For instance, if you sell on 30-day terms, and all your customers are kind enough to pay up exactly on time, your debtor days will be 30.
But if you’re in the same situation as most businesses, your customers are sure to take longer than that. If they delay a whole month, your debtor days will be 60 – a totally unsustainable situation.
What is net cash flow?
Cash flow stress occurs when your cash is going out faster than it’s coming in. Your suppliers want their money in 14 days, but your customers demand 30-day terms and then string you along even further.
To work out your net cash flow, find out how much cash you had in the bank at the beginning of the month, and how much you had at the end. Take the second figure away from the first, and you’ll have a net result.
But is it a positive number or a negative number? If you had $10000 at the beginning of the month and $12000 at the end, your cash flow is positive to the tune of $2000 for the month.
But if you started with $10000 and finished with $8000, your cash flow is negative and you’re $2000 out of pocket.
You can live with negative cash flow for a while, especially if it’s because you’re investing money to grow the business. And lots of businesses have a run of negative months followed by a run of stronger, positive months, especially if demand for their products is highly seasonal, like Christmas decorations.
But if you’re engaged in business as usual, yet you feel like you’re supporting everybody’s company except your own, you should try to solve the timing problem. Your main tactic is to bring forward your income by shortening the period over which you allow your customers credit.
What can I do about it?
You need to take action, fast, to bring down your debtor days and speed up your cash flow. Invoice finance can be one solution to this problem, ensuring you get paid immediately for work done and goods delivered.
That way you can get off the wheel of chasing accounts receivable and get your hands on your money, straight away, to reinvest in your own business.
It is important to always put together cash flow forecasts so you understand the peak periods for cash usage and can plan accordingly. It might mean leaving cash in the business, delaying creditors, putting of capital expenditure or reducing expenses temporarily in the months prior to ensure there is enough cash to tide your business over in the busier months.
Or you might consider a more immediate solution in the form of invoice finance. With this, the financier pays you the majority of your invoice value as soon as you issue it, and the remainder, less a small fee, after they’ve done the hard work of chasing up your customers for you.
