Chapter 4 -
Understanding cash cycles

One key to hanging on to more cash is understanding and fine-tuning your company’s cash cycles. How long, for example, is the time between purchasing a truck and collecting the first freight bill? You can manage only what you measure. How much cash will you need for every new truck or $100,000 in new revenue? By understanding these cycles, you will be better able to anticipate cash needs and better prepared to meet them.

What are cash cycles?
A cash cycle is the time between when you spend cash and when you receive your cash return on that investment. If you examine carefully the time of each step in the cycle, you probably can speed up the process.

Tracking cash cycles is a time-consuming effort, but it’s worth it. If a company has $6 million in revenue, then each day’s revenue is about $16,500. If you can reduce your cash cycle by one week on average, you can have a one-time cash windfall of more than $115,000. On the other hand, if you let your cycle accidentally expand by one week, you’ll need that much in cash to finance it.

Usually, these cycles are expressed as operating processes inside your company. The three major cycles that we will discuss are accounts receivable, accounts payable and new equipment acquisition. If you find that revenue is high and you are running profits but have no cash, it’s because your money is tied up in one of these cycles. All three of these cycles interrelate, but we will attempt to investigate them independently.

The first step is to chart cash cycles, as shown by Worksheet 4-1. By charting cycles, you can see exactly where your money is and how to convert it into cash. Your money may be in your customers’ accounts, invested in your employees’ services, your utility providers’ account or your suppliers’ accounts. Should it be?

Principal cash cycles
Accounts receivable cycle. The accounts receivable cycle begins when the driver pulls away from the dock after delivering the load. How long will it be before you invoice? When you create an invoice or bill in your accounting system, you record that sale in two places. You record the revenue on your profit-and-loss statement and in your accounts receivable on your balance sheet. This asset represents cash that another company eventually will pay to you.

You just completed a delivery; start your cycle clock ticking at this point. The cycle will end when you have cash in your account at the bank. Let’s walk through the cycle, step by step.

Your driver delivers the load and, assuming no backhaul, returns home. If the trip takes two days, you will have the paperwork in your office in two days. A receivables clerk in your office prepares an invoice. This activity may take a day or two, depending on the amount of work this person performs or the process used to send the bill. If the bill requires authorization from another person, then keep adding to the time your customer has your money rightfully. Then you send the bill to the customer through the speedy U.S. Postal Service. All this time, you do not have your money, and you are extending the time on your accounts receivable cycle.

Finally, your customer receives your invoice and decides to pay in a reasonable time of 20 days. Twenty days later, the customer sends a check through the mail. You receive the check in the afternoon and can’t deposit it until the next day. Finally, you can stop the clock.

Although the customer paid you in 20 days, your accounts receivable cycle is much longer. You must add all the time your driver held onto the paperwork, all the time your office shuffled it and all the time it took the post office to deliver the invoice and the check. You should reduce this time in every possible way. Chapter 6 will help.

Assume that your accounts receivable cycle is 45 days. If you add $100,000 in new sales, you’ll add at least $12,000 to $15,000 in new accounts receivable.

Accounts payable cycle. The accounts payable cycle is similar to the accounts receivable, except now you are the one controlling your money. Suppose you buy tires. Start the cycle clock when the tires are on your trucks or, perhaps, when you add the tires to inventory. The clock continues to click until your supplier deposits your check.

Assume your company profit margin is 6 percent, and your operating ratio is 94 percent. That means that for every $100,000 in revenue, you have $94,000 in expenses. If your payables cycle is 15 days, you’ll have only about $4,000 in accounts payable at any one time. This is reasonable considering that much of your purchases are driver or employee costs with shorter times, netted against other bills that may give you 30 or more days.

When you consider the two cycles together – $15,000 growth in receivables, less $4,000 growth in payables – you see that you’ll need at least $11,000 in cash to finance the growth. And you haven’t even bought the truck yet.

Equipment acquisition cycle. This cycle encompasses several of the other cycles and is extremely critical. Buying a new truck seems to start with the cash outlay on the down payment. Actually, it might begin earlier, as you lay out cash to plan the expansion or spend valuable time negotiating with dealers. The cycle does not stop until you receive cash for the first delivery attributable to that truck. Let’s walk through the steps until we reach the accounts-receivable starting point, since the new truck cycle ends and the accounts receivable cycle starts at the same time.

After paying the down payment of $10,000, you must pay for tags, registration and licenses that could add up to $1,600 or $1,700. Then you must locate, hire, orient and train a driver. You must also advance him operating money for meals, salary and fuel. You must cover these operating costs continuously once the driver begins to deliver. These costs might range around $8,500 per month – $3,500 salary, $2,500 fuel and $2,500 other.

Remember, you may not receive any money for this truck for at least 40 days. This depends on your accounts receivable cycle. Assuming a 20-day start-up period for the truck and a 40-day accounts receivable cycle, you may be out of cash for 60 days on a new truck.

In Summary
To picture your cash cycles, think in terms of starting a new company that has just one supplier, one customer, one employee and one truck. Add all the time each financial transaction takes, step by step. When you add other suppliers, customers, employees or trucks, simply start new cycles. To improve your cash position, investigate each cycle individually.