For all those in business, and even those of you thinking about going into business, listen up. I am going to explain what cashflow is, how it works and how it is the number one killers of businesses.

When a business fails it has run out of cash, not profit. Therefore cashflow which is the cornerstone of is working capital. Management of both cashflow and working capital is absolutely imperative to survival.

So what is working capital?


Working capital is the transient funds used to support a business' day to day operations. So it is the money used to purchase of inventory, pay wages and bills. The money used to pay these things comes from one source; sales.

So by that logic cash flow is the analysis of how the cash from sales goes to paying your bills. On the face of it, you may just think that cashflow is as simple as money in & money out. Unfortunately it’s never that simple and here’s a demonstration:

Say you’re in a commercial office furniture business. First you need to fill your showroom with stock so you approach your supplier and order $10,000 worth of stock. The stock arrives and with it comes an invoice for 30 days terms. You put the stock up for sale, and hope that you’ve sold them all before that invoice is due. The 30 days comes due and you haven’t moved much stock, but you have got some cash in the bank so you pay your invoice on the due date like a good customer. The 30 days it takes you to pay your suppliers (creditors) are known as creditor days. The average time it takes you to pay these creditors is an important measure of cash flow performance.

The important measure is inventory turnover. How long does it take you to sell all of that stock that you just bought? Let's say in this example it’s 50 days until you get turnover all your stock. So when a customer buys this product the product gets delivered and you issue an invoice with 30 day terms. Unfortunately your customers aren’t as courteous as you are and it takes them 60 days for them to pay the invoice. This is known as your debtor days, and represents the last critical measure of working capital management.

So let’s put it all together in some sort of timeline. So you ordered stock, it arrived, you were issued an invoice for the order, in 30 days you pay that invoice, 20 days after that you sell the stock and issue an invoice, 60 days after that you actually get paid.

You can see there that we’re going to have some problems if we continue to do business this way.

Stay tuned to our next article to see what we can do to address some of these problems. You can also download a copy of our free eBook for an more in depth look at how to fix your business' cashflow.