How to Measure and Manage your Cash Flow
Monitoring cash flow is the key to staying out of the red. Here's how.
By Craig Wagener,
D. Optom, M.B.A., Ph.D., Key West, Fla
One critical element in business is managing cash flow. It goes without saying that
business owners are in business to make a profit. Professional optometric offices
are no different. But that's not enough.
Strange as it may seem, businesses that are making a profit can still go bankrupt
because of negative cash flow. In this article, I'll explain the basics of cash flow
management and provide some tools to keep your practice on track.
Ebb and flow of cash flow
So what is cash flow? Simply put, it's the flow of money in (revenue) and out (expenses)
of a business. If expenses exceed revenue, the business has a negative cash flow.
A new business or an older one in an expansion phase may experience a period of negative
cash flow. You can plan for these situations and use bank overdrafts, lines of credit
or cash capital reserves to cover your expenses. However, a day of reckoning will
come when these sources are depleted, and if the business hasn't become strong enough
to compensate for its needs, insolvency is the inevitable outcome.
If you think charging more for goods and services will take care of everything, you're
taking a big risk. It's unlikely that you'll be able to raise fees enough to solve
your immediate problem.
That's why careful financial management is so important. It will improve your liquidity
now and provide a buffer against a temporary rise in expenses. It also will see you
through slow times and times when the unexpected occurs, such as illness.
Monitoring your cash flow is an important aspect of successful management. Activity
ratios can help you do just that. These are very simple equations that measure the
relationship between various components in a business. All you'll need is some accurate
data and you'll be able to calculate the current status of your cash flow situation
in a few minutes. And if you have a simple spreadsheet program like Microsoft Excel,
you can let the computer calculate it for you.
Add it up
Two activity ratios -- the average collection period (ACP) and the average payment
period (APP) -- will give you the information you need to make sure your business
is headed in the right direction. Here's how they work.
First, calculate the yearly ACP:
(Accounts Receivable ÷ Total Number of Sales)
x 365 (days in the year) = # days
This tells you the average number of days it takes your practice to collect the money
needed to cover yearly expenses. It also may be helpful to look at this number on
a monthly basis.
To calculate the monthly ACP:
(Accounts Receivable x 30.42 days in a month)
÷ Revenue for the Month = # days
For example, let's say your receivables as of the end of December total $45,000 and
your revenue for December is $40,000.
(45,000 x 30.42) ÷ 40,000 = 34.2 days
This tells you that it's taken you an average of 34.2 days to collect the money you
need to pay your expenses. But you're not finished yet.
Next, calculate the yearly APP:
(Accounts Payable x 365)
÷ Total Year's Purchases = # days
Accounts payable is the average balance outstanding for the year. This equation tells
you the average number of days it takes to pay your bills.
To work on a monthly basis:
(Accounts Payable x 30.42)
÷ Monthly Purchases = # days
Monthly purchases include items such as frames and contact lenses as well as your
lab account, and so on, but it excludes overhead expenses.
Let's say your your accounts payable for the month of December total $40,000 and
your purchases total $30,000.
(40,000 x 30.42) ÷ 30,000 = 40.56 days
This means that, on average, it takes you 40.56 days to pay your bills. Now we easily
can see that, on average, the business is collecting its receivables in 34.2 days
and paying its payables in 40.56 days. This is a healthy situation.
Reverse the Flow
In case you do the math and find that you're already in a negative cash flow situation,
here's how to get back in the black:
Inform patients that fees are due at the time of the examination. Place notices
in your reception area.
Collect deposits before placing customer orders.
Collect the balance when patients pick up their orders.
Remind patients that their order has arrived.
Send bills to insurance companies the same day as the eye examination.
Follow up on bills submitted to insurance companies.
Before accepting an insurance plan, verify the amount it will cover and that it
will pay you directly.
For outstanding bills, offer a discount if payments are made within 7 days.
Negotiate an extended payment term with suppliers.
Reduce staff hours, if possible.
Replace only what's been sold in your dispensary.
Review overhead and reduce anything possible.
The key to achieving positive cash flow is to make sure that the average collection
period is less than the average payable period. This means that the inflow of money
is greater than the outflow and positive cash flow is the result. You should perform
these calculations monthly to keep track of your cash flow.
Cash in, cash out
Two other figures also are crucial to effective cash flow management: These are simply
a record of the cash-in and cash-out each month. All you need to do is add up the
total amount of receivables for the current month and then add up the total amount
paid out for the same period. You can easily get these figures from your bank statement
at the end of each month. To keep yourself in the black, it's important that your
cash-in figure is greater than your cash-out figure on a regular basis. All four
figures work collectively to measure the total cash flow of your business.
The ACP and the APP will let you monitor your cash flow's movement. You should analyze
these figures as a measure of the current positive or negative cash flow as well
as relative to the preceding months. If the ACP begins to increase compared with
previous months, then your billing staff may need to make some phone calls to improve
the billing cycle, or you may need to revise your credit policies. On the other hand,
if your APP is too low, then you may have to negotiate more favorable terms with
The reason the ACP and APP aren't stand-alone figures is that the APP doesn't take
your overhead into account as part of the payables. This is why the cash-in and cash-out
figures complement the former two and give a true picture of the actual cash flow
So good luck with the use of these cash management tools, and remember positive cash
flow is the name of the game!
In private practice since 1978, Dr. Wagener currently practices part-time and runs
a marketing and management consulting business.