Want to give your clients the best experience and sign better deals? It pays to know how the cashflow funding gap affects business, and how you can help your customers bridge the gap. For Small to Medium Enterprises (SMEs) across a range of industries in Australia, managing cashflow is a major and ongoing challenge. In 2022, 43% of businesses surveyed in the Banjo SME Compass report increased their prices to customers just to improve the cashflow position within their business.
The cashflow funding gap — the disparity between cash inflows and outflows — is very real, and it poses significant challenges for businesses aiming to grow and thrive. In this article, we’ll delve into the key triggers of the funding gap, explore strategies to manage inventory in light of the gap, address seasonal and resourcing challenges, and discuss ways in which you can help your clients improve their cashflow position.
Similarly, if your clients need funds to improve their cashflow position and reach their business goals, we’ll help you prepare the information a reputable finance provider (like Banjo) will need. This will ensure the application process is as prompt and responsive as possible.
While there is work involved to really understand your client's financial and cash position, we’ve found this to be a defining characteristic of good brokers who subsequently reap the rewards of high-quality clients referring business.
Part One: Explaining the Gap to Your Clients
Put simply, the cashflow funding gap arises when there’s a time lag between money flowing out of the business (expenses) and money coming back into a business (revenue). This may be caused by delayed payments from customers, high operating costs, or rapid business expansion that strains financial resources.
Business owners in the initial startup, or Launch, stage need to expect this lag between profit and sales cycles as a matter of course, as well as negative cashflow that dips even lower than profit due to the capitalisation costs in establishing the business. This is the make-or-break stage in a business lifecycle, with finance often received through investors or by the business owners selling assets and floating start-up costs themselves.
Cashflow can be an issue for entities in the next phase of a business lifecycle, the Growth phase, too. Additional cash is often required to scale up after acquiring a new contract, or to meet statutory payments like staff superannuation and tax liabilities that can crop up in the proceeding years after their business launch. Want to know more about the business lifecycle and how it relates to funding? In all cases, it pays to keep a watchful eye and know how to identify the signs of a cashflow funding gap starting to form.
Key signs of a cashflow funding gap:
Delayed Payments: Longer payment terms, late-paying customers and the burden of collecting outstanding invoices can significantly impact cashflow.
High Operating Costs: High overhead costs – including rent, salaries, and utilities – can put a strain on cash reserves.
Rapid Business Growth: Growth is desirable but it can lead to significant and immediate upfront investments, which may then outpace incoming revenue.
Seasonal Sales Fluctuations: Businesses operating in seasonal industries often deal with irregular cashflow patterns throughout the year.
Inventory Management: Capital tied up in slow-moving or obsolete stock can result in cashflow issues.
The good news: There are some simple early-stage strategies your clients can implement to address these cashflow problems.
Addressing the cashflow funding gap:
Improved inventory management: Efficient inventory management practices – such as just-in-time inventory or regular stock reviews – can help reduce inventory holding costs and free up working capital.
Better seasonal planning: Careful planning for off-peak periods – including setting aside reserves during peak seasons to cover expenses during slow periods – helps smooth over the seasonal dips.
Smarter resource optimisation: Identify where resources can be optimised, such as cross-training employees to handle multiple tasks or outsourcing certain functions to minimise fixed costs.
Diversification: Exploring new markets or product lines can help mitigate the impact of seasonal fluctuations, as well as reduce dependency on a single revenue stream.
Sourcing a Business Loan to Bridge the Gap
While implementing the above strategies can improve cashflow, SMEs may still encounter funding gaps. In such situations, securing a business loan with a lender like Banjo can be an effective solution.
As opposed to a personal loan or mortgage facility, there are some important processes you need to employ in preparing client information for a better application, approval and funding process. As a starting point, your due diligence should include:
Assessing funding needs: Before you approach lenders, evaluate the precise amount your client will require to bridge their cashflow gap. Understanding their funding needs will help in selecting the appropriate loan type.
Researching lenders: Conduct thorough research to identify lenders that offer business loans tailored to your SME clients’ needs. Carefully compare interest rates, repayment terms and the eligibility criteria to help them make a more informed decision.
Assess the viability of a short-term loan: For SMEs with temporary cashflow challenges, short-term loans can be beneficial. These loans typically have a shorter repayment period and enable your clients to cover immediate expenses.
Considering a business line of credit: A business line of credit offers flexibility for your customers to draw funds as needed, up to a pre-approved limit. Interest is only charged on the amount borrowed, making it an attractive option for managing fluctuations in cashflow position.
Explore invoice financing: For SMEs who are struggling with delayed payments, an invoice financing facility gives them upfront payment from a lender against their outstanding invoices, which helps maintain a steady cashflow.
Check for financial readiness: Ensure your client has the required financial information they will need to lend, up-to-date and ready to go.
Part Two: How Inventory Works in the Cashflow Equation
Your clients can improve their cashflow funding gaps by scrutinising their inventory and identifying ways it can be managed better. This includes using calculations to determine if there is a gap or one that may emerge.
Let’s take a look in detail.
Understanding Stock Turns
It is important you understand the number of inventory turnovers, or turns, your clients are seeking to achieve as a business, which is basically the time it takes for a business to sell its entire inventory. This will largely apply to businesses in their Maturity and Extension stages, and not so much for entities at Launch stage.
Bear in mind, the amount of stock turns often varies. Some retailers focus on 4 turns a year, while a wholesale distributor may focus on only 2 turns a year.
To work out inventory turnover, the following calculation is used:
Inventory turnover = Cost of goods sold (COGS) ÷ (0.5 x Opening inventory + 0.5 x Closing inventory)
If the result is 4, for example, this means an entity completely sells out and replenishes their inventory four times a year. This number will help you to recognise whether your clients’ stock levels are too high or too low, and assist them in adjusting accordingly.
Real Time Inventory and Just In Time (JIT) Inventory
Now you’re armed with data about your clients’ inventory turns, you can explore the inventory management system that will best improve their cashflow position.
In many instances, the two most effective inventory management systems are Real Time inventory management and Just In Time (JIT) inventory management.
(1) Real-Time Inventory
These days, it’s not enough for your clients to eventually know their inventory and stock levels; they need to know this information right now.
Deploying a solution that gives everyone up-to-the-second updates on stock levels has multiple benefits. Not only does smarter and more efficient stock replenishment ultimately drive a better customer experience, it also gives your clients a direct insight into how cashflow is manifesting itself on the warehouse floor.
Case Study:
Emma & Tom’s is a proud Australian-owned business offering healthy, minimally processed fruit-based products. They were experiencing rapid growth and were required to manage multiple inventory locations. Dealing with fresh foods required zero lag in operations and inventory, so they made a decision to implement an Enterprise Resource Planning (ERP) system that enabled them to effectively manage their inventory. This decision drove a 30% year-on-year growth. (2) Just in Time Inventory
No matter whether your client’s business is in a Launch, Growth, Maturity or Extension stage, wastage and shrinkage have an enormous effect on cashflow. If stock is lying around for weeks or months in a warehouse or on a shop floor, it’s increasing the likelihood of reduced profits.
Pioneered by Toyota in the 1960s, Just in Time (JIT) inventory management — the ordering of products or materials at each stage in the process so they arrive 'just in time' to be used and sold to customers — has proven an effective supply chain model. JIT eliminates latency and greatly reduces wastage. The knock-on effect: improved cashflow for the business.
While the JIT supply chain model works well for medium to large enterprise businesses, it may not work for small businesses who don’t have the purchasing power or the demand to get the most out of this type of supply chain. But ERP software solutions, such as SAP Business One, are growing in popularity with small and mid-size businesses to simplify their entire supply chain process for adopting workable JIT models. Supplier Relationships
Suppliers are business people, just like you and your clients, so they understand the realities of inventory management. Accordingly, establishing flexible supplier relationships is a great way to improve cashflow in any business.
Encourage your clients to develop good relationships with their suppliers by being proactive in negotiating mutually beneficial credit terms. This will provide them with some breathing space and better management of their inventory cashflow.
Which products are your clients’ best sellers? Which products are flying off the shelves and into the hands of their customers? Which products are taking longer to shift? Knowing these answers is key to a firm grasp on the management of inventory.
Armed with such information, your clients can then turn their attention toward their suppliers. If a supplier is delaying supplies of fast-moving stock, this is going to lead to delays, which will also harm cashflow. In this instance, maybe your client should consider working with someone else? On the other hand, if the stock is a slow-burning seller and difficult to source, it may be worth continuing to work with the supplier.
Facilitate and Incentivise Instant Payments
Many SMEs see invoice lag as part-and-parcel of being in business. Customers get the goods they need, an invoice is provided and then the wait for the exchange to be settled begins. This doesn’t need to be the case.
Do some exploration to see if your client provides customers with the ability for instant payment. No one likes unpaid bills hanging over them, so making it easy for customers to pay instantly via credit or debit card can significantly reduce cashflow issues. Sourcing a Business Loan to Bridge the Gap
While implementing the above strategies can improve cashflow, SMEs may still encounter funding gaps. In such situations, securing a business loan with a lender like Banjo can be an effective solution.
As opposed to a personal loan or mortgage facility, there are some important processes you need to employ in preparing client information for a better application, approval and funding process. As a starting point, your due diligence should include:
Part Three: Understanding the Cashflow Conversion Cycle
In simple terms, the cash conversion cycle – or CCC – is the number of days it takes for a company to convert its inventory into cash generated from sales. This is important: as business owners, your clients invest in products because they want them to sell and generate profits. Understanding how quickly this is achieved is vital to addressing a holistic view of their cashflow situation.
In a good cashflow conversion cycle, the quicker invested cash can be converted into end returns and profits (the lower the CCC ratio), the better.
Why is the Cashflow Conversion Cycle Important?
There are two reasons why the cash conversion cycle is such an important metric for a business.
The CCC is a clear indicator of efficiency in handling and managing working capital assets, particularly critical assets such as inventory;
A CCC offers a viewpoint from which to gauge liability management, i.e., how effectively a company is positioned to be able to pay off its current liabilities.
Most contemporary financial reporting focuses on quick and current ratios designed to measure the speed in which an organisation can sell its inventory to make way for more stock. The CCC, however, takes things a step further: it measures how quickly your client’s company can turn this inventory into sales, and then from sales into receivable cash. This makes the CCC ratio a far better demonstration of a company’s liquidity.
The CCC also helps to identify where cashflow issues are coming from. The longer inventory remains unsold, the longer it takes to collect the accounts receivables. When we factor in a shorter payment window for debts to company suppliers, we can see that cash is being tied up in inventory, and available cash is being quickly depleted as trade payables are managed. Over time, this trend will squeeze the available cash a company can draw upon, greatly reducing liquidity because of its cashflow pressures.
Your clients can use these calculations to spot positive and negative trends in how their company manages its working capital. With a low CCC ratio, there is less need to borrow additional capital and more opportunity to achieve pricing discounts through direct cash purchases on materials. There is also an increased capacity for growth and expansion. This is what you, in partnership with your clients, should work towards.
How to Calculate Cashflow Conversion
Calculating the CCC requires assessment of three distinct stages of the cashflow conversion process:
Days Inventory Outstanding
Days Sales Outstanding
Days Payable Outstanding
Stage 1: Days Inventory Outstanding — DIO
Firstly, the existing inventory level is taken into account, and we consider how long it will take for a business to sell off its inventory. This is represented in the calculation as Days Inventory Outstanding.
DIO = (Average inventory ÷ Cost of Goods Sold) x 365 days
Stage 2: Days Sales Outstanding — DSO
The second calculation examines the current sales, and the time taken to collect cash generated from these sales. This is the Days Sales Outstanding figure – or DSO.
DSO = (Average Accounts Receivables ÷ Revenue) x 365 days
Stage 3: Days Payable Outstanding — DPO
The third calculation focuses on the current outstanding payables of the business. This usually relates to money owed from the company to its suppliers for the current inventory. In terms of the calculation, the figure is the time-period in days for the company to pay off this debt, and it is represented as Days Payable Outstanding.
DPO = (Average Accounts Payable ÷ COGS) x 365 days
To complete the calculation, we use the following formula;
Cash Conversion Cycle (CCC) = DIO + DSO - DPO
Getting these three smaller calculations correct is vital and must be completed before the cash conversion cycle can be gauged.
The CCC in Action
Let’s put it in the form of an example…
John is a wholesaler selling bathroom accessories to large residential developments. He purchases his inventory from one main vendor, and pays off the outstanding balance on accounts within 30 days to achieve a discount. His inventory turnover rate is 4 times a year, and he collects accounts receivable from large property developers generally within 45 days on average.
John’s CCC is calculated in the following manner:
Days Inventory Outstanding (DIO) = 90 days
Days Sales Outstanding (DSO) = 45 days
Days Payables Outstanding (DPO) = 30 days
DIO + DSO - DPO = 105. So, John’s cash conversion cycle is 105 days. In other words, it takes 105 days for John to get from paying for his inventory to receiving the cash from its sale.
The more that John can reduce his CCC figure, the less pressure there will be on his cashflow.
To reduce his CCC, a broker could discuss with him some of the strategies we’ve already mentioned, including supply chain management to reduce inventory levels, smarter debtor collection (offer discounts for 7-day payment or offer online settlements) and negotiating better payment terms with his suppliers.
In conclusion
It goes to show, having a good cashflow can make or break a business, particularly one that’s in the Launch and Growth stages of the business lifecycle.
Data released by Creditor Watch in July 2023 showed, in June 2023, B2B trade payment defaults reached record highs, with a 52% year-on-year (YoY) increase. Creditor Watch also noted that credit enquiries rose 161% YoY.
And those record highs are unlikely to decrease “CreditorWatch’s national default rate prediction for the next 12 months,” noted Michael Pollack in an article on the data, “is for an increase from the current rate of 4.71% to 5.76%.”
To avoid becoming a default statistic, you can help your clients pick up on problems before they arise, including:
The triggers and signals of cashflow issues and introductory steps to mitigate them;
How better inventory management can reduce the strain caused by poor cashflow;
The importance of establishing good relationships with your suppliers;
Calculations and metrics for monitoring cashflow;
Working through these steps with your clients will help provide a clearer picture of more than cashflow; it can also help determine where finance could provide a solution to a cashflow squeeze and improve liquidity.
Furthermore, it will ensure you have the data on hand to prepare an application for finance that’s responsible and responsive. And, you never know, it may even help you with your business too.
Speak to Banjo about how we can help bridge the cashflow funding gap.
* Disclaimer: Fees, lending criteria, terms and conditions apply (including an origination fee on each advance). Actual fixed fee (or interest expense) and repayments will vary based on your individual circumstances. Advertised rates are subject to change at any time. Fixed fee (or interest expense) accrues upfront and is paid in instalments. While Banjo does not generally take security over assets, director guarantees may be required and a general security deed or other security may be required for larger loans or in respect of some loan types. Statements regarding timing in relation to applications, approvals and funding are only indicative. Any advice given does not take into account your personal circumstances and you should carefully consider what products are appropriate for you and obtain professional advice where relevant.
