The Cash Flow Gap

Put simply, a business's Cash Flow Gap is the cash shortfall created by having to pay for expenses some time before getting the cash in from the sale of goods or services.

For businesses selling on credit terms, the entire cash flow cycle can be more than 120 days – a period of time in which your business has to keep paying all the bills for production, paying the rent and keeping the lights on, while waiting for payment.

As a business grows, expenses are bigger, and the size of the Cash Flow Gap therefore also gets bigger. 

This creates a very significant cash requirement,  and should be a central focus of regular cash flow forecasting and budgeting: The “Cash Flow Gap” is a measure which is useless in hindsight.

The Cash Flow Gap Can Be Terminal!

Alarmingly, a busy business with lots of sales and which is rapidly expanding is most at risk of running out of cash completely.  

If that happens, even if only temporarily, a good business can become the victim
of its own success, and go broke. This is a deadly combination of fast sales and
slow cash, and is referred to as “over-trading”.  

Insolvency accountants – the undertakers of the accountancy profession – are
called in to bury such businesses almost every day.

The Consequences Of A Too-Tight Cash Flow

Insufficient cash in your business has a number of bad consequences.  For
example:

• Without the cash you can‟t confidently bid for more work, because you have no way of knowing how to pay for the people or materials needed to get the job done on time. Lost jobs mean lost profits and lost opportunities for the business to build valuable business relationships. 

• You can't bargain as hard as you would like to with suppliers – because you can't offer to pay sooner, or order in bigger quantities. 

• Relationships with creditors – the people you owe money to – can become strained. Your creditors probably need your money as badly as you need to delay payment! This chain reaction of slower payments affecting most businesses has become worse in recent times. The average payment time is now up around 60 days. 

• When cash is tight, your debt collection efforts can become unbalanced. So instead of focussing more on the slow paying customers, you press for payment from the easy targets – often your best customers. This is clearly not helpful to the relationships with your top customers. 

• The tighter the cash flow, the closer you need to watch cash balances. This can absorb a huge amount of your management time – often daily – wasted in examining, planning, tracking, manipulating and prioritising cash flows,  rather than an orderly month-to-month planning and
  budgeting process, much of which can easily be delegated to lower-skilled staff. 

• There's no room for surprises. Most small businesses learn to expect the unexpected on a daily basis: An employee leaves, something breaks down (hopefully not you!) or something comes up at home. All need an urgent response, which usually means spending money you hadn't planned to.

• Without a cash buffer to fall back on, these daily crises can become a major source of stress.

We've coined the term "Cash Flow Hygiene" to refer to the collection of regular tasks a business should carry out to avoid negative impacts of the Cash Flow Gap.