No matter the size of your business, collecting payment from customers for products and services rendered is going to occupy an important place in how you run things day to day. Your company literally can’t survive without it! So you’re going to want to get a good handle on the time you can generally expect to wait to receive payment from your customers: this is where the cash collection cycle comes in.
What is the Cash Collection Cycle and Why Does it Matter?
The cash collection cycle (not to be confused with the cash conversion cycle) is a measure of the number of days it takes for you to receive payment (or collect on receivables) from your customers, from the date of delivery of a product or service until the payment for that product or service flows in. If you want to understand and improve your company’s profitability, then you’ll need to have a good idea of the expected length of this cycle.
The main reason you need to pay close attention to your cash collection cycle is that it is directly related to your cash flow. In a nutshell, cash flow is a measure of the amount of money flowing in and out of your business. If you don’t have enough cash coming in (cash inflow)—or not coming in on time—you can find yourself in a difficult financial situation pretty quickly. The good news is that if you understand your cash collection cycle and take steps to use it to improve cash inflow, you can avoid problems before they crop up.
A Typical Cash Collection Cycle
Let’s take a look at what an average cash collection cycle might look like for a small business. Once a sale has been made and the product or service delivered to the customer, you’re going to kick off the cycle by issuing an invoice. The time factored in for delivery of that invoice will depend on whether you’re sending it electronically (instantaneous delivery) or by snail mail (a more extended delay, depending on the chosen postal or delivery service).
The next step in the cycle is when the invoice due date rolls around: generally 30 days after the date the invoice was created (although this timeframe—or term—may vary depending on the type of business, the client, and the particular sale). The cycle comes to a close when the client sends you their payment, whether it’s by check, credit card, bank transfer or another payment solution available today.
Given the general timeline above, the cash collection cycle would take just over 30 days, assuming the client pays you on time. (Again, this may vary from business to business or sale to sale.)
Keeping the Cycle Short and Sweet
Ultimately, you want your cash collection cycle to be as short as possible. A shorter cycle means accelerated cash inflow, leading to more cash in hand sooner, which allows you to cover your business’ financial obligations in a more timely and predictable way.
So how can you shorten your cash collection cycle or at least make it more predictable? Start by putting in place smart invoicing practices, like double-checking to ensure all relevant details are included (such as your company’s contact details, a clear breakdown of the products/services rendered, invoice due date (which is different than the net term), and acceptable payment methods). A reminder call or email before the due-date rolls around (or afterwards, in the unfortunate case of late payments) can also go a long way toward making sure you get paid.
Keeping on top of your company’s cash collection cycle can go a long way towards effective management of your finances. Putting practices in place to shorten or control this cycle will help you to get paid on time—which is the name of the game, right?!
And hey, if all else fails in shortening the cash collection cycle, send in a Kangaroo.