Slow down consume cash

Why Trading Slowdowns Consume Cash

 

 

‘The Cheque is in the Mail!’ What happens to cash when your collections slow?

Every business is subject to cash flow ups and downs throughout the fiscal year, but slowing cash collections can create a permanent deterioration in your cash position. 

What happens to cash when your collections slow down?

Let’s focus on accounts receivable, as it probably the most critical balance sheet account for a business trading on credit. But before we start, why would they slow? There are in fact two major reasons for a slowdown:   

  • Customers are actively extending payment terms or simply not paying as fast as they have in the past, or
  • You are offering extended terms to customers to boost sales

As collections slow, the receivable holding period grows, just watch the receivables account balance below. More cash has to be found to finance everyday operations until these accounts receivable convert to cash. The slowdown usually has two outcomes; either the company has to borrow the additional cash themselves or they resort to slowing supplier payments to preserve cash.

Payables are a source of spontaneous finance, when payables slow, cash is conserved. However every account payable is actually someone else’s account receivable. If a business slows the rate at which it pays its suppliers, it will automatically increase the accounts receivable of those suppliers. This is a typical cause and effect, in fact it is the domino effect I discussed in an earlier blog. You now have some choices to make!

Let’s see what actually happens on the balance sheet when payments slow down.

Suppose payments terms are 30 days, and all sales are on credit. Then the monthly sales and accounts receivable balance would look like this:

  J F M A M J
Sales 50  60 55 58 61 65
Receivables 50 60 55 58 61 65

 

Accounts receivable mirror sales as they are created and paid within the 30 days. 

Now let’s see what happens when collections slows to 60 days. Accounts receivables balances will now look like this:

 

  J F M A M J
Sales 50 60 55 58 61 65
Receivables (Previous Month)  NA 50 60 55 58 61
Receivables (Current Month) 50 60 55 58 61 65
Total Receivables  NA 110 115 113 119

126

 

All sales in January and February appear in the February receivable account as customers are taking twice as long to pay and a cash timing difference occurs. In the example here, you can easily see the cash impacts of the slowdown.

Slowdowns in the cash conversion cycle, for whatever reason, adversely impact the cash balance and  impact everyone in the supply chain. You can make sure to keep control over your accounts payable and inject a new source of working capital into your supply chain by settling up a supplier early payment programme with Tradebridge.

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Murray Stevenson
Sales Director
Woodsford TradeBridge