Measure your "Spread"

A quick measure of your business’s health is to measure your “Spread”.  

Cash + Receivables – Payables = Spread

Receivables are a predictor of how much money is coming in soon.

Payables are a predictor of how much money is going out soon.

Cash is how much you have.

The net is like looking out the windshield to see what is coming, while financial statements are looking in the rearview mirror at history you can’t change.

If your Spread is negative, you are in trouble.

The goal is not to get the Spread as high as possible, but to keep it at a number that is safe – where you know you won’t run out of cash and have some reserves should things slow down or surprises come up.

If you know you are going into a slow season, you may let your Spread rise higher than normal.

Assuming your company is profitable, the valve you have to adjust the Spread is whether you are taking any money out, usually in the form of distributions to shareholders.  You could also decide to pay for capital investments rather than finance them depending on your Spread.

If your company is losing money, your Spread is likely low or negative.  The only tool you have then, broadly speaking, is to fix your business and make it profitable by one or more of the following –

Raise prices if your gross margin is too low.

Lower direct costs if your gross margin is too low.

Lower fixed (indirect, G&A) costs if they are too high.

Increase sales if your gross margin is ok and you can’t trim indirect costs any further.

Increase the size of your average sale.

Increase the number of sales.

Increase the frequency of sales from the same customer.

Increase sales while keeping fixed costs the same.

Lower fixed costs while keeping sales the same.

Some combination of all of these.

More on the “Spread” tomorrow.