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The Effect on Cash Flow of Improving Receivables Collections

Posted on July 2nd, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In this article from Entrepreneur Magazine, How to Better Manage Your Cash Flow, the author explains, “At its simplest, cash flow management means delaying outlays of cash as long as possible, while encouraging anyone who owes you money to pay it as rapidly as possible.” And the starting point is in measuring and projecting cash flow. He then lists various steps that can be taken to accelerate payments on accounts receivable, and delaying payments to vendors to the extent possible.

On the measurement of cash flow, in my previous article, “Cash Flow Expressed as Asset-Based Borrowing Availability,” I demonstrated an alternative way of looking at cash flow, by forecasting future borrowing availability against accounts receivable and inventory. This method is particularly useful for companies that are in a growth mode, or otherwise have heavy working capital requirements and are unable to maintain large cash reserves.

To illustrate the effect of accounts receivable on cash flow, first view the below projected cash flow with accounts receivable turnover assumed to be 45 days.  Note that for this company to maintain a minimum cash balance of $10,000, it must rely heavily on its “asset-based” (accounts receivable) line of credit.

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Now look at what happens to cash flow if the company is able to improve receivable collections from 45 to 30 days:

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Note that now under “Asset-Based Credit Facility – Borrowing Availability” the company is projecting a gradual paydown on its line of credit, to the point where by year-end, it is able to pay off its line and start to accumulate more cash in its bank account.

The above scenario proved to be critical for a client I worked with several years ago. For various reasons, the company was maxed out on its line of credit, and the only way it could free up borrowing availability was to ask its best customer (at the time) to pay down its receivable balance.

 

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