What is a Business Cash Gap?
The joy of every business owner is that the business becomes and remains profitable. This is why most people equate business success to making a profit. However, successful businesses are not all about making a profit, although profit is also a huge part.
The real success lies in maintaining the cash flow of the business during good and bad days. Imagine having a substantial billion-dollar sale today, and then the next few days feel like your business is about to go into bankruptcy just because the money went into getting a piece of new machinery or paying of the employees? That’s why every small business owner needs to understand the concept of working capital, cash flow, and a business cash gap to sustain the growth and financial state of the business.
Cash flow, Working capital, and Cash Gap in Business
When there is cash in a business, things work. Everyone is happy. But to keep the cash, a business owner needs to pay attention to how money goes in and out of business. The cash flow is how money moves within a business (movement of money between income and expenses).
Understanding cash flow helps a business know how much can be used for daily expenses. Working capital is the money that is available to run day-to-day expenses within a business. Understanding working capital helps a business avoid borrowing money to run expenses.
So, what is a business cash gap? A business cash gap is the number of days between when a business pays for a service or product, and when it receives payment for a product/service provided. For instance, if a business pays its taxes, the number of days it takes the business to receive money from a product or service it provides is its cash gap. If a business does not manage these concepts, the business can be making sales, and still run into a loss.
Understanding a Business Cash Gap
For most businesses, there are always expenses to take care of even on days of a cash gap. During a cash gap, there is only a little to run the business until the next sale. This amount needs to be managed properly so that the business won’t have to borrow. But sometimes, the cash gap days are so long that a business might need to apply for a short-term business loan. These loans are usually available within 24-48 hours and can be accessed using a trusted business loan company.
However, the more cash gap days a business accumulates, the more interest to be paid. In other words; the more a business cash gap, the more money goes out of the business. And the less a cash gap, the less a business has to worry about interest rates and credit. Therefore, it should be a business’s major goal to reduce its cash gap since it directly affects the profit the company makes.
Ways to Reduce Your Business Cash Gap?
There are a few ways to reduce or shrink your business cash gap. These include:
Cash Flow Management
Cash flow is the movement of money-in and money-out. Understanding how your business runs, the outstanding invoices, debts, how much raw material is left, and so on can help a business owner determine his business’ break-even point. Working towards a positive cash flow will directly slim down your business cash gap.
Reduce your cash outflow
As a business is trying to manage the cash flow, it can also reduce (or delay) its cash outflow. Subscriptions can be lengthened so that cash does not have to be released so often. Also, direct deposit into employees’ bank account can help cut off bank costs. Another way a business can reduce cash outflow is the optimization of the payroll process.
Encouraging customers to pay on time
It is no doubt that a recipe for business failure is when customers owe. Encouraging customers to pay on time can shorten the cash gap, especially if sales are continuous.
Small businesses need to learn when and when not to make major spending. Buying a piece of machinery or a franchise when the cash gap is long can cause the business more harm than good. The business should spend on what brings cash back into the business.
This is another way to shrink cash gaps. When a business incorporates the habit of building a cash reserve, it can use this money saved during the dry days. The more solid a business cash reserve is, the easier it is to manage cash gaps and maintain its financial state.
Shorten collection periods
If your business can’t incorporate the pay-before-service system, you can shorten the length of time it takes for your customers to pay. Some businesses don’t deliver the product (or service) until payment is made, therefore, these businesses have short or no cash gaps at all.
How to calculate the cash gap?
The cash gap of a business can be calculated within the business. And it can be determined using the formula: inventory days on hand + receivables collection period – account payable period = cash gap.
Where inventory days on hand is the number of days it takes a business to completely utilize the inventory remaining in the company’s stock. The receivables collection period is the number of days it usually takes a client to pay the business for a product or a service rendered. And the account payable period is the number of days it takes the business to pay its suppliers for products or services received.
Managing cash gaps
During cash gaps, it is best to manage the amount of money that goes out of the business. To collect a loan during a cash gap is not forbidden. Though the interest might become a cash outflow when the cash comes in, when the loan is favorable, it might not be such a bad decision. The business owner has to take into account loan opportunities with low-interest rates, fast delivery time, and long payment due dates. With these parameters, the business can maximize the amount of interest that would be paid.
Cash gaps generally are not favorable when they are too high, but they can’t be compared between two businesses. The rate at which a business spends and sells is different from another. As a small business owner, study your cash flow and working capital so that you can know how low your cash gap should be. This way, you can cut off unnecessary interests caused by long cash gaps days, and maximize profit.