Lesson two, the speed of cash. Here are the five things you're going to learn in this lesson. First, you understand the key drivers of the cash conversion cycle. Be able to identify if your company has enough money to operate. Three, learn the levers that can improve cash flow for know how much money you have, and how much you need to operate, and five, practice cash flow management by using the speed of cash dashboard in cash flow tool. now's a good time to check out those supplemental materials.

They aid and guide you through each lesson. So let's get started. Welcome to Lesson number two in our business cash flow essentials training course. And today we're gonna be talking about the speed of cash. You know, some We measure speed in miles per hour, kilometers per hour. But today we're gonna be talking about the speed of how money moves in and out.

We're not talking about cars, we're talking about cash and cash these moves in days. So why don't we talk about it? Because cash flow is that important. You can generate a profit, but you can also run out of money. Think about it this way. You got a very popular company brand new company.

They have a great product and it's selling like hotcakes. As soon as it gets hits the shelf people are buying it, the company is reordering, which means the people that bought it from you to begin with or reorder because they want to satisfy that demand. And you are selling everything that you can make, maybe even faster than you can make it. Do you think a company like that can run out of money. They can, you can actually outrun your operations, you cannot run your cash flow. So that's what we're going to talk about today is how to manage your cash conversion cycle of the money coming in versus the money going out.

One of The things that we talked about is, what are the top reasons that businesses fail? Right? The reason why we exist, the reason why cashflow tool exists is that we're trying to solve the top reasons that businesses fail and out of the top 10. Seven of them involve poor cash flow management. That's right, seven. So it's that important.

And what we want to do is eliminate that as a reason that your business might fail or not. Or even if you don't have a cash flow problem today, we don't want you to be surprised tomorrow. So here's what we're going to look at, we're gonna look at what are the causes, you know, there's drivers and all kinds of cash flow, what's coming in versus what's coming out. We do little things every day to kind of hurt ourselves. We might invoice poorly, right? Not create the invoice in a timely manner.

We might carry too much inventory might be paying our suppliers too fast. Other things we might do is just extend credit to the wrong persons. Now what we've got to do though, is be able to determine how do we measure the levers that control the cash coming in and out so What I like to do is give you this visual, this visual of your company should run like a machine. That's right. Just like a machine, it should just generate and spit out cash for you all the time, you know, you have to be there and cash is coming right over your company. So when you think about a machine or what you think a gears, right just big gears turn it, because you want it to crank through there just as as easily as you can.

So here's the two gears that I want to think about small gear and a large gear, the small gear, we're going to use that as our driving gear. That's the gear that we use to drive cash into the company. And those numbers that we're going to use come right off the balance sheet. The small gear turns real fast. So we want to consider that to be a fast, small little gear. You're looking at inventories you're looking at AR you're looking at AP so that's inventory, your accounts receivable and your accounts payable for the driven gear the one that little one is propelling.

We want to think about a big gear that moves slow. We want to move low as possible, the numbers we're going to use for that come right off the income statement. Right? How much cash do you have? And how many days will that last based on your spending patterns. So that's the cash outside.

That's the driven gear. So let's break it down into those two gears, think about the small little fast gear called the driving gear, and the big, large slow gear called the driven gear. Those are the two we're thinking about. Here's the driving here, driving gear involves your working capital. Right, your working capital really tells you whether or not your business generates enough cash to actually sustain its own operation. You know, can you stay in business just based on what you sell.

The way you calculate your working capital is you take your current assets, which is stuff that you can convert to cash really fast are usually within this year, and you subtract your current liabilities. Those are those that you owe this year, like your credit card. An example of your current asset could be your checking account. So we'll use those examples to kind of explain how the working capital works. Now working capital is usually Know expressed in dollars, but you can't convert it to a ratio, we call that the current ratio. The current ratio will tell you how many dollars that you actually have to pay for debt.

Here's an example. Remember, we talked about checking account as a current asset, and your credit card is a current liability. So when we divided this time, instead of subtract, we take current assets divided by current liabilities, it comes up with that ratio. In this case, we've got a 1.45. Yeah, I got a current ratio 1.45. Here's what they says, For every dollar that you own your credit card, the current liability, you have $1 45 and checking to pay for it.

That's the way to read the current ratio for every dollar you owe. How many dollars you had to pay for it, or how many times over could you pay for, in this case, I could pay for it. One, well, almost half, one and a half times. So that's how you express it. Why are we doing this because those levels would just talk about the current assets and current liabilities. help me determine whether or not you have a gap.

And I'm talking about a cash gap, I'm talking about the financial gap. And the financial gap is a period of time where you've run out of money, you're waiting for money to come in from your customers. While you've already paid all your vendors or all your suppliers. If there's a difference, if there's a gap, you need money to cover that gap. So you can keep continuing to pay your expenses, like your rent your salaries, you're gonna need cash to cover that period. Generally, you have to have enough cash in your checking account.

Sometimes you might leave a line of credit, using this cash gap or this financial gap calculation will help you determine how much you should have on that line of credit. So here's how you calculate the financial gap. First, we're going to look at money coming in, right? So we go out and we put inventory on a shelf and we put the inventory on the shelf, somebody buys it, but it's not on the shelf for a certain number of days. And then when they buy it, we sell it to them on credit when Give them the invoices system their desk for a certain number of days. That's how long it takes for money to go out your pocket and come back in.

Now, all the meantime, you're paying your bills. So bills are sitting on your desk, you're making the payments. When you subtract that amount of time, the time it takes you to make your own payments, from the time you're waiting for money to come in. The difference between the two is the financial gap. So we got inventory and AR accounts receivable. And then we have a P. That's how we're going to calculate its inventory, plus AR minus AP equals the financial gap.

So here's the three levers Okay, inventory. That's how long products sit on the shelf. You got accounts receivable, that's how long you're waiting for money to come in from your clients or your customers. And then you have accounts payable. That's how fast you pay your vendors. Let's do a sample problem.

And then the sample problem I'm going to use these numbers in your supplemental material. There's some financial statements from spectrum manufacturing. These numbers come right off their financial statements, we're going to be using year number five in these financial statements. So when you look at it, you'll see your one, your five, your five is the most current, or the one that just happened the most, most current current year. Looking at the working capital, here's what we calculated. When we express it as dollars.

Its current assets minus current liabilities, we have $2 million in current assets, we have 1.5 million and current liabilities gives us working capital $530,000. Is that good? Well, we don't know. We just know that's how much we have. We call that amount, the cushion, I have a cushion of $530,000. That means if I take all my current assets, and I pay off all my current liabilities, I still got $500,000 left over seems like it's good.

But we haven't analyzed how our business runs yet. And when we analyze how our business runs, then we can figure out how much we need. This is just the amount of money you have. This doesn't say how much you need. Now, express In our working capital is a ratio, we've got the same $2 million in current assets, the same $1.5 million in current liabilities. When we divide the numbers, we get a 1.35 ratio.

That means for every dollar that we have in our credit card that we owe, or our accrued expenses that we owe, we have $1 35 and checking to pay for Is that good? Well, we don't know, I usually like to have a two or better on the current ratio. What I can tell you is that it's better than below one, we at least have enough money to cover our own expenses. So our business is viable in that point. But is it generating enough cash to run our business? When you look at your working capital number, it could be positive like it is in this case, could be neutral or negative.

Now we almost always want it to be a positive number. Neutral is one word you just practice in just in time. The auto industry tried to do that in the 90s and actually got in trouble. I wouldn't suggest that to anybody but that's spending the dollars as they come in. It's almost a passer additionally is the negative, right lastly is the negative one negative is generally bad, that means you're spending more money than you have coming in. Now, when I say generally bad, that means there are some industries, like SAS based products or software based products that are subscription base that may run with negative cash flow in the beginning years.

And then as the waterfall effect takes over, in the later years, they work themselves out of it. So there are some businesses as a start, we'll start off in the negative cash position or negative working capital position, where I want you to focus positive working capital. Let's calculate the financial gap for this company. In this case, we've got inventory cost of goods sold, accounts receivable, accounts payable and sales, back to our chart. And again, you can get this right out of your supplemental materials as well. When we calculate inventory, we turn it into a day's number.

We determined that we have 90 days worth of inventory and that's our Inventory divided by our cost of goods sold. And we multiply that by the days of the year 365 gives us 90.29 or 90 days, when we do the same thing with AR, we determined that we had 34 days, that means we're waiting 34 days for money to come in. So we have 90 days of inventory, and then we wait 34 days for money to come in. All the meantime, we're paying our bills, we pay our bills in about 56 days, using the same methodology of converting the turnover rate. Today's in this case, we've got $750,000 in our accounts payable, we divide that by across to get sold and multiply it by 365. Because those 56 days, you see this gray part that's missing.

Yeah, that's our financial gap. We take the inventory plus AR and subtract out AP gives us a financial gap of 68 days. That's 68 days that we're waiting for money after we've already spent what we have in our checking account. That's the financial Yeah. So what do I do with it? What we just determined is that I have a gap or need of 68 days, I have worked in capital of 530,000.

Remember, that's what we said we have, we have a cushion of 530,000. But when I use the cash gap, to determine how much money I need, I determined that I need $916,000. How would I do that? Well, basically what I do is I take my average daily expenses and multiply that by 68. That's the amount of days I don't have money. And when I have that, that gives me a need of $916,000.

I have, I have 500. I need 900 which gives me a cash shortage now of $386,000. I'd write $386,000 of what I need. I'm short. So if I was going to go into the bank and ask for a loan, instead of saying, I don't know how much you give me, Mr. banker, I can actually say hey, listen, this is the way my business works. I got 90 days of inventory.

I'm getting paid in about 34 days, I'm paying my bills and 56. And based on that, I need a loan for about $400,000. I've calculated that and I can express that to my banker, and actually give him some methodology and give him some ammo to go fight for a loan in a loan committee for me, how's this different first service business? It's really interesting. Because in the service business, you don't have any inventory. So that number is going to be zero automatically.

But you probably have some AR, you're waiting for some money to come in. Right? And in my case, I should run a hotel staffing company. When I had the staffing company, I would have employees go after the hotels, they would work at the end of the week, I would send an invoice to the hotel, then I would wait to be paid. In my specific example. It was 45 days.

So if they worked at a Marriott or worked at a Hilton, I would wait 45 days from the time I submitted the invoice to get paid. Here's something interesting because I paid every two weeks, right so every 14 days I had to make money. payroll. And let's pretend that my number was $100,000 every 14 days. That means in 45 days, I would have three different payroll periods that I had to pay my employees. So I'm actually out of pocket for $300,000.

While I'm waiting for my first check to come from a hotel partner, or my hotel client, so that means I've got a need of $300,000. That's how you determine how much you're going to need for a service business. Another way you can do it is just by saying I need one and a half times my operating expense. I like to use payroll because I never want to be behind on payroll. So for me, payroll seems to make much more sense. And I can put that into my AR days and figure out how many times I have to make payroll before money actually comes in.

That's the driving gear. Now let's talk about the driven gear, the big gear, remember the driving gear, we want that to be fast. And what I mean by that is that financial gap has to be small. So in this case, it was 68. But smaller is better because it's smaller. I need less money to run my business.

On the driven gear, I want it to be big I want to move slow, right? So I want the days that I calculate to be a lot, which means I want cash to stay in my company a long time. The metric we use for the driven gear is days cash on hand. This is how many days of cash I have available. Before I go bankrupt, I sometimes I call it days the bankruptcy. But in this case, it's days cash on hand.

And that's by taking my average daily expenses divided by how much money I have, how many days can I live, if I had no sales, and you can remember that this assumes that you have no or low sales. One with one thing you can do with this is calculate Do I have enough money to cover my seasonality. So if you know you have a low sales period during the summer of 60 days, this number should be at least that I say it's always should be 45 days or higher. But make sure that you're looking at your seasonality as well. Let's calculate up using the same Example numbers that we have for spectrum manufacturing, they've got $85,000 in cash, they've got $2 million in operating expense, and they have non cash expense in their income statement as well. This is actually the depreciation expense, we're going to take that out, because nobody ever writes a check for depreciation.

So let's calculate up okay $85,000. And I'm going to divide that by my operating expenses and subtract out my non cash. I'm going to divide the whole thing by 365, which gives me 16.71 days or 17 days, let's round it up. How do I interpret it? Well, here's a handy chart to help you interpret what these mean again, I want you to have 45 days or more, the higher the better, right? This is that big gear, the number of days we want to be large or the driven gear.

Now if you're having zero to 15 days, this is where you should watch out right this company actually has 17 days so that says they have a small cushion, but they need to keep an eye on the cash flow right they actually should be moving towards that for Five days. But here's a chart you can use to measure your own company. Now, here's something that gets just a little bit tricky. We've talked about your working capital, we've talked about days, cash on hand. And now I want to talk about the cash shortage, right? So I've thrown a lot at you.

Here's what you might see, right when I say it gets tricky is because you might see a metric that says, I have a lot of cash on hand. But you got to remember cash on hand assumes that you have no sales. So that's why we look to the cash shortage, the cash shortage, you can say, okay, just as my businesses running as my business is operating, Do I have enough to keep it operating? Not saying if we run out of sales like these cash on hand does this is saying just running my business on a daily basis? Do I have enough money? So when you see these two, they operate separately?

They don't operate together so you got to look at them with a little bit different financial lens on it. Now, how do you control your speed right? We've talked about the gear, we've got the small gear, the small, fast gear. And it's small because we're looking at one number and what's that number, the financial gap. And we want that financial gap to be as small as possible. That's right small.

So think about a small gear spinning really fast. And in order to control your speed on the small gear, you get three levers to pull, you get inventory, you get AR, and you get AP. So what you can do is reduce your inventory, reduce the amount of time it takes you to collect or increase the amount of time it takes you to pay. That's your only options. If you want the number to be smaller, you have to move those three levers in that direction, smaller inventory, collect faster, pay slower. Those are the three things you do to control your speed on the driving gear.

On the driven gear. This is the one you want to be large, right? driven gears days, cash on hand, that's the number you look at days, cash on hand. We want that number to be as large as possible. We're means you have a lot of money and you can live for a lot of days, right? It's days to bankruptcy, you want that to be way down the road?

The number you want it to be as a middle is 45 days. That's right You want 45 days cash or more. Now some people say what's the right amount to have? I know what the minimum is. But I will know what the right amount to have is. Well, the right amount is somewhere between three and six months operating expenses.

So if it takes you $10,000 per month to run your business, you need to have 30 to $60,000 on hand, right? That's about how much money you're going to need. Now, some people talk about war chests and like Oh, wait a second, the big companies they got a thing called a war chest. Well, a war chest is something that you have to fend off threats, maybe even last through a natural disaster, or take advantage of opportunities. Maybe there's a purchase you can buy another company, a war chest or an abundance chest as some people like to call it. These would be about 18 to 24 months worth of operating So taking that same number, that $10,000 per month, you're going to need somewhere around 180,000 to $240,000.

That's an abundance chest. So that's how you control your speed. You want a lot of cash on hand, and a little financial gap, small gear, large gear. So here's your homework. If you notice, you've already got your cash flow tool account. And one of the dashboards we already created for you is the speed of cash.

That's right. Everything you just learned in this little lesson is already built for you in the speed of cash. You're gonna have your inventory days, your AR days, your financial gap, your shortage, all of that is already built for you already. Well, it's already ready. All you have to do is go look at it. So here's your homework.

Go ahead and open up your cash flow tool account. Look at your speed of cash dashboard and try to put it back into what we just learned. Do you have enough Do you have a shortage is your small gear the financial gap Small is your large gear days cash on hand large. Here's your lesson lesson number two is the speed of cash.