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these terms, they're vital to your business. Learn all the important aspects of analyzing and improving your cash flow.
The Relationship Between Accounts Payable and Cash Flow Establishing Credit Terms for Customers Managing and Accounting for Your Inventory
Read more about Cash Flow
To properly manage your business's cash flow, you must first analyze the components that affect the timing of your cash inflows and cash outflows. A good analysis of these components will point out problem areas that lead to cash flow gaps for your business. Narrowing, or even closing, cash flow gaps is the key to cash flow management. Some of the more important components to examine are:
Accounts receivable. Accounts receivable represent sales that have not yet been collected in the form of cash. An account receivable is created when you sell something to a customer in return for his or her promise to pay at a later date. To properly manage your cash flow, you must know the negative cash flow affects caused by the time it takes your customers to pay on their accounts. Credit terms. Credit terms are the time limits you set for your customers' promise to pay for the merchandise or services purchased from your business. Credit terms affect the timing of your cash inflows. Offering trade discounts is one way you might be able to improve your cash flow. Credit policy. A credit policy is the blueprint you use when deciding to extend credit to a customer. The correct credit policy is necessary to ensure that your cash flow doesn't fall victim to a credit policy that is too strict or to one that is too generous. Inventory. Inventory describes the extra merchandise or supplies your business keeps on hand to meet the demands of customers. An excessive amount of inventory hurts your cash flow by using up money that could be used for other cash outflows. Accounts payable and cash flow. Accounts payable are amounts you owe to your suppliers that are payable sometime within the near future, "near" meaning 30 to 90 days. Without payables and trade credit you'd have to pay for all goods and services at the time you purchase them. For optimum cash flow management, you'll need to examine your payables schedule.
average collection period measurement using the average collection period accounts receivable to sales ratio accounts receivable aging schedule using the accounts receivable aging schedule
Current Accounts Receivable Balance Average Daily Sales Average Collection Period =
The average daily sales volume is computed by dividing your annual sales amount by 360:
Using the annual sales amount and accounts receivable balance from the prior year is usually accurate enough for analyzing and managing your cash flow. However, if more recent information is available, such as the previous quarter's sales information, then use it instead. Be sure to compute the average daily sales correctly using the number of days actually reflected in the sales figure (e.g., 90 should be used if a quarterly sales amount is used).
David owns and operates an auto supply and repair shop. David's total annual sales amount from the previous year was $200,000. The total balance of his accounts receivable at the end of the same year was $20,000. David's average collection period is calculated as follows: David's average daily sales volume is $556 per day:
$20,000 = $556 For David's previous year, each dollar of sales was invested in accounts receivable for 36 days. Assuming that David's business has not changed drastically from last year, the cash inflows from sales on account will not be available for cash outflow purposes for 36 days. 36
$200
$300
$400
$500
$600
Investment in Accounts Receivable 30 40 50 60 $ 6,000 8,000 10,000 12,000 $ 9,000 12,000 15,000 18,000 $12,000 16,000 20,000 24,000 $15,000 20,000 25,000 30,000 $18,000 24,000 30,000 36,000
The above chart illustrates the effect that a change in the average collection might have on the investment in accounts receivable for your business. Remember, accounts receivable represent money that cannot be used for other cash outflow purposes. For example, assume that your average sales amount per day is $300, and that your average collection period is 40 days. Now assume that you were able to reduce your average collection period from 40 days to 30 days. From the illustration above, you can see that the reduction in the average collection period reduces the investment in accounts receivable from $12,000 to $9,000. This reduction generated an additional $3,000 in your cash flow.
Accounts Receivable Accounts receivable to sales ratio = Sales for the Month
Dick's accounts receivable balance at the end of the previous month was $15,000, and the total sales amount from that same month was $10,000. Dick's accounts receivable to sales ratio of 1.5 is calculated as:
$15,000 $10,000
Accounts Receivable Aging Report Roth Office Supply October 31, 2011 Total Accounts Receivable $1,600 2,800 1,000 1,600 2,000 400 600 1,200 $11,200 1-30 Days Past Due $ 500 ------1,600 500 400 ------$ 3,000 31-60 Days Past Due $ 500 ---------400 ---------$ 900 Over 60 Days Past Due $ 300 ---------------------$ 300
Customer Name
Current
Quick Computer Supply Kitchens by Voels Jansa's Sport Stores Bradley Farms, Inc. TrueBrew Unlimited Enneking Enterprises Hove and Sanborn LLC J. Siegel, CPA Total
If you're using one of the many available accounting software packages for billing and accounts receivable processing, check it first to see if it prepares the aging schedule automatically. Most accounting software packages will prepare an accounts receivable aging schedule at the touch of a button, but always check, and don't forget to solicit your accountant's advice.