The Fastest Way to Grow Cash Flow in Your Business
Navigating the maze of financial metrics in business can be overwhelming. But understanding how to effectively manage cash flow is a critical aspect for the astute business owner.
Let’s break down the essence of cash flow for business owners and leaders.
How to Improve Your Cash Flow
Understanding Cash Flow Dynamics
Cash flow isn't just about injecting your own money or taking out loans. It’s about the strategic balancing act between your gross profit percentage and your working capital percentage.
Gross Profit Percentage
This is the ratio of your gross profit (GP, or revenue minus the direct cost of production) to your revenue. Consider this: If your business generates a revenue of $100,000 and the cost of production is $50,000, you're left with a gross profit of $50,000. This means your gross profit percentage stands at 50%. (Note this is a simplified example - if you're actually achieving a GP percentage this high, you're excelling!)
Working Capital Percentage
In the simplest terms, your working capital (WC) percentage is the summation of your debtors, stock, and work in progress minus your creditors, related to your annual revenue. The aim? To increase the difference between the gross profit and working capital percentages.
Related post: The Power of Effective Working Capital Management
Key takeaway: The proven strategy to improving cash flow is increasing the gap between your gross profit and working capital percentages, with GP being the higher of the two.
Elevating Gross Profit Percentage
Two core components influence GP percentage: revenue and costs.
Increase your revenue by:
- Selling more: Aim to increase sales without elevating the working capital value. Admittedly, this is a challenge (and by challenge we mean 'virtually impossible') – expecting more output without a corresponding rise in debtor or stock values.
- Have more profitable offerings: Let’s say you offer two products – Product A with a GP of 25%, and Product B with a 33% GP. By selling more of the latter, you can naturally boost your overall GP.
Reduce your direct costs with:
- More efficient production: The objective here is straightforward but impactful. Produce the same amount at a reduced cost. Whether it's through better sourcing or efficient labor practices, it's about retaining quality while trimming costs.
Related post: What Factors Impact Pricing Your Goods and Services?
Optimising Working Capital Percentage
- Debtors: Ensure you get paid as quickly as possible.
- Hold stock for a shorter period of time. The faster your stock turnaround, the better your WC.
- Convert work in progress (WIP) into invoices promptly. As these are assets, doing this will improve your WC.
- Maximise your creditor days: This doesn't mean delaying payments or stretching our your creditors unethically; rather, it means ensuring you're getting the best possible terms from your suppliers.
Related post: Understanding Creditor Days in Under 2 Minutes
Shrinking working capital number in turn improves your working capital percentage, ultimately helping grow your cash flow.
7 Ways to Grow Cash Flow in Your Business
In summary, use these methods to increase cash flow in your business:
- Sell more, without increasing the dollar value of your working capital.
- Focus on offerings that have a greater gross profit percentage.
- Reduce production costs without compromising on quality.
- Get paid from your debtors more quickly.
- Increase your stock turnaround.
- Reduce your work in progress (WIP) by converting into invoices faster.
- Get the best possible terms from your suppliers.
Every business owner dreams of more liquidity. To achieve this, the strategy is simple yet profound: elevate your GP percentage and curtail your WC percentage. By widening the gap with the GP percentage taking the lead, you release more cash into your business.
Understanding and manipulating these two percentages means you're not only ensuring a robust cash flow, but also solidifying your foundation for a thriving business.
Remember, the journey towards financial literacy isn't about mastering every nuance, but understanding the pillars that strengthen your business.
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