In order to drive growth in your company, you’re going to need to be smart with your cash. Managing peaks and valleys with your cash flow can be complex, especially if you are a first-time founder/ business owner, but not impossible. In the last module, It’s All About The Cash: Balance, Runway and Cliffhangers, we discussed part II of cash flow fundamentals. But that was only the start. This section will delve into NET terms and how to anticipate and manage cash flow gaps. Don’t know what a cash flow gap is? You’ve come to the right place.
Cash Flow Management
NET terms are essentially the amount of time you have to pay your bills or the amount of time your customers have to pay you.
NET terms are typically divided into two buckets:
Think of “NET” as the number of days an invoice is due once it has been issued. So if you agreed to NET 7 terms with a vendor, you have seven days to pay them in full once the invoice is generated. Typically vendor or customer agreements will specify NET 7 from the delivery of an invoice or NET 7 from the presented invoice. This puts the ownership on the group issuing the invoice. The sooner they issue, the sooner they can get paid. So NET 14 would be 14 days from the invoice date, and NET 30 would be 30 days.
Discounted terms are similar in concept to Non-Discounted, but now you’re offering a discount for the customer to pay sooner. For example, 1% NET 10/NET 30 means you’re giving a customer a 1% discount off the invoice value to pay in 10 days. If they don’t pay in 10 days, they owe the total amount of the invoice in 30 days. 2% NET 10/NET 30 means you’re giving a 2% discount if they pay in 10 days but owe the total amount in 30. Remember, while some vendors or customers may demand specific terms and say that’s the best they can do, keep in mind that everything is negotiable. It’s always a “No” if you don’t ask.
Moving along, the Cash Gap is the time difference between your company paying a supplier and receiving payment from a customer. This is essentially a period where the business is not collecting money on money it has already spent producing products or generating services.
The Impact & Cost of a Cash Gap
Let’s say you sell inventory to a customer and give them NET 20 terms. The total outstanding invoice is $10,000, and you will have a cash flow gap of 20 days. If you’re not in a strong financial position, you may need to borrow that money to cover those gap days.
Suppose we look at a loan with an 8% annual interest rate. Then we look at the number of days you have that money to cover; you will pay $2.19/day to borrow that money or $43.80 in total for the 20 days.
If you do this for multiple customers, the numbers can really add up, so it’s critical that you understand your cash flow gap and the cost to you.
30customers x $43.80 x 12months = $15,768 per year you are paying in incremental costs to cover those gaps.
The shorter the gap, the less money it will cost you to cover it.
Efficient Business Models
Businesses with digital products and services that don’t have physical inventory are incredibly efficient because these businesses get paid immediately when the services or products are provided to the customer. Typically these are credit card-driven transactions in which funds can be available in as little as one day in your bank account.
Alternatively, businesses with physical inventories that are needed to sell to customers tie up cash in inventory. Depending on how much inventory you carry and how fast or slow you sell this inventory, it will directly affect the amount of money you will need to run your business.
- Having a cash gap costs you additional money to cover it
- Negotiating favorable net terms with your vendors & customers is the single biggest factor in minimizing your cash gap
- There’s an artform to effectively managing your cash flow gap
- Life Lesson: Everything is negotiable. The answer is always “No” if you don’t ask
Congratulations, you are one step closer to becoming a financial whiz.