Get out and stay out of Tax Debt by understanding your cash flow cycle

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Why your business cash flow cycle is critical to getting out and staying out of tax debt

Understanding your business’ cash flow cycle and planning your business’ funding to match that cash flow cycle is crucial to your business's success and ensuring that you don’t find yourself in the Tax Debt Trap.

What is the Business Cash flow Cycle?

In essence, a business’ cash flow cycle is the amount of time it takes between when the business pays for stock (i.e., for a wholesale or retail business) or wages (i.e., for a service or manufacturing business) and when that business gets paid for its product or service.

Let’s look at a new wholesale business’ cash flow cycle to illustrate how critical this issue is in ensuring the success of your business.  It’s essential that you know your business’ cash flow cycle to plan for its cash flow needs, ensuring that your business is not undercapitalised, which is one of the main reasons businesses find themselves in the Tax Debt Trap.

Cash Flow Cycle

Example of a new wholesale business cash flow cycle

In this example, the business is new, so it doesn’t have any supplier accounts so it must pay for stock COD.  

This business also has implemented 30 days payment terms for its customers; on average, the stock sits on the shelf for 35 days (i.e., stock days). 

Wages are $1,000 per week, and they sell the stock with a 100% markup.

Day 1 Purchase $10,000 in Stock

Day 7 Wages of $1,000

Day 14 Wages of $1,000

Day 21 Wages of $1,000

Day 28 Wages of $1,000

Day 35 Wages of $1,000

Day 35 Stock Sold for $20,000 

Day 36 Purchase a replacement $10,000 in stock

Day 42 Wages of $1,000

Day 49 Wages of $1,000

Day 56 Wages of $1,000

Day 63 Wages of $1,000

Day 65 Receive Payment of $20,000

Day 70 Stock Sold for $20,000

Day 70 Wages of $1,000


As you can see in this example, in the period shown, the business has made a profit of $20,000 after wages but is down $10,000 after 70 days and, at its peak, needed $29,000 of working capital to fund its business cashflow cycle.

Undercapitalised businesses often use the PAYG Withholding, employee super, and GST money to fund this cash flow need, thinking they will pay it back down the track when they get paid.

The Problem

The issue is that it often never happens because, as the business grows, the cash flow drain increases rather than fixes itself.

This is also why, paradoxically, the business owner’s first instinct to “work harder” to fix the business tax debt problem just worsens the problem.

The harder the business owner works, the more the business sells, and the worse the cash flow drains on the business.

Understanding the Cash flow Cycle

It’s not until you understand your business’ cash flow cycle that you can make a plan for it, and potentially make the changes necessary to ensure your business is successful.

So, in the above example, what could the owner do to ensure the business doesn’t find itself in the Tax Debt Trap?

Avoid the Tax Debt Trap

1. Given the highest level of cash needed in the above example was $29,000, the owner could inject $30,000 to $40,000 of their own money into the business as seed capital.

2. The business owner could borrow $30,000 to $40,000 from a bank to fund the start-up of the business.

3. The business could apply for a Debtor Funding facility which funds 75% to 85% of the business's debtors until those debtors are paid, or they reach 90 days. In this scenario, at 80% funding, this would mean that the business would receive $16,000 on Day 35, which reduces the total amount of capital funding the business needs in the above example to $15,000. Obviously, the business is less profitable due to the interest on the Debtor Funding facility but the cash flow needs of the business have been nearly halved.

4.  The business could apply for an account from its suppliers.

5. The business could reduce its customer payment terms from 30 days to 14 or 7 days.

6.  The biggest thing this business could do is reduce its stock days from 35 days as much as possible.  At 35 stock days, the business has to pay five lots of wages while the stock sits on the shelf, and even a 30-day supplier account won’t help much because the stock days are longer than even a 30-day supplier payment terms.  

The reality is that the best way to fix this issue is to implement a number of different strategies at the same time. 

If this business could reduce its stock days to 10 days in conjunction with 30-day supplier payment terms, its cashflow requirement would reduce from $29,000 to $15,000.

This amount would still need to be funded personally or from a bank.

If a debtor funding facility was put in place, the amount of funding required to float the business reduces to $1,000.

As you can see, knowing your business’ Cash Flow Cycle, understanding what it means for the cash requirements of your business, and taking steps to ensure that your business has the cash it requires to operate is essential to the long-term success of your business.



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