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Understanding the flows and ebbs of cash in your business is critical to scouting for warning signs of impending cash crunches. Bookkeeping software like QuickBooks can tell you that you will be getting money in the door, but without knowing when, you’re going to be left not knowing if you can pay the bills.

The activities that your business carries out can be broken down into several events. For a manufacturing business, these main events would be:

• Buying the raw materials
• Paying for the raw materials
• Manufacturing the product
• Selling the product
• Collecting cash from the customer

The events for service and retail businesses are similar. For ease of presentation, we will use a retail business in our examples.

Let’s have a look at a simple example:

One day, you purchase inventory for your store for $100. You pay the bill to the supplier 30 days later. After 15 more days, a customer buys the product for $125. Your customer buys on credit so she does not actually pay you for another 45 days.

So, you know you’re making a profit on the sale, however, you may miss the fact that it is a total (in this example) of 90 days between the inventory coming in the door and going out the door (the inventory holding period) and it is a 60-day span between cash going out the door and cash coming in the door (the cash float).

Why do we need to know the inventory holding period and the cash float? Because, we need to make sure that we can pay for the inventory when it’s due. There’s a 60-day cash flow gap between us paying suppliers and customers paying us. Now that we have that information, we need to ensure that we have the financial resources to “float” that inventory.

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Written by: Angie Mohr
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