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How a Cash Gap Plan Saves You From a Shortfall (and Five Ways to Do One)
A cash gap plan is a relatively simple and very necessary method of managing the flow of money into and out of your business. It’s the only way a business owner can rest easy. You’ll know that you’ll have enough money for payroll, bills, and needed expenditures.
A cash gap is the number of days between paying for goods and services and the payment from your customers.
Cash flow is key to business survival whether your business is growing or struggling.
In any small business, resources (money, inventory, material assets) are scarce. So you want to use them to the fullest advantage. It follows that you need to ensure that your cash gap is as low as possible. You manage what you have against what you are owed. With a low cash gap, you can use the cash to repay debt and to invest in the growth of your business.
There are some well-known companies that actually have a negative cash gap! Think Amazon and Dell Computers. These businesses collect their money before they ship products. The closer you can move your business in that direction, the stronger your business will be.
To maintain a low cash gap, you must set up a plan that’s carefully monitored by your management team.
Essentials for Managing the Cash Gap
Here are four fundamentals which managers can employ to keep the deficit as low as possible.
Controlling and Reducing Inventory
One way for managers to keep the cash gap low is to take a closer look at inventory in order to minimize your investment. Let’s say that you have slow-moving items in the warehouse. This could be due to seasonal demand, improvements in materials, or other factors. You can reduce this cost burden by:
- selling the items for scrap
- trading them with a competitor or supplier
- offering a special sale
- returning them for credit
In addition, managers can review company purchasing policies. For example, they can try to get consignment arrangements in exchange for longer-term contracts.
2. Speeding Up Receivables
You know that the faster you receive remittance for products and services, the lower the cash gap.
Encourage prompt payments from customers by following up with reminder phone calls, emails, or past-due letters. Before you make a sale, you can offer discounts for early payment. You can also have payment methods like PayPal or Square to ensure a fast turnaround on money owed.
You can also assess if invoice delays are happening due to a lack of communication or processes within the billing, sale, or production staff. Addressing these issues will certainly improve your situation.
Lowering Days in Accounts Receivable
Most small businesses allow their customers to pay within 30 days. While this varies from industry to industry, you can try to lower your payment terms. For example, a manager can offer a small discount if the customer pays within five days.
In the case of international customers or historically slow-paying clients, consider getting a deposit or transfer before you provide a service or manufacture a product.
Managers should continually review accounts for slow-paying customers. If the trend is increasing for this type of customer, consider engaging a collection agency.
Negotiating Better Terms With Your Suppliers
The next way to improve your cash gap is to negotiate better payment terms with your suppliers. Perhaps you can go from paying in 30 days to 45 days. You can inform your suppliers that your customers want longer terms and that you have a cash gap that you need to improve.
When you have a small business, it will always be important to plan ahead. Even though you take all the measures possible to avoid problems, you may not lower the cash gap as much as you would like. So, it is always best to have good cash reserves available just in case you may need to use it.
A higher cash gap can handicap your business, even to the point of failure. There are several tactics that a company can do to prevent such a gap. You can collect payments from your clients sooner, renegotiate your buying contracts with suppliers, or purge stale inventory.
Be sure to evaluate your plan regularly. This practice will ensure that you’ve covered all the available ways to decrease the likelihood of a cash gap.
Have you tried to implement a cash gap plan? If so, how did it work for you? (Answer below in the comments section)