Case
Study — The Cash Flow Gap
This example shows how easily a cash flow gap can occur in a
small business. A cash flow gap is a shortage of cash caused by
the mismatching of cash outflows and cash inflows.
John makes custom furniture for professional decorators and
furniture retail shops. In addition to himself, John has two
other employees. John pays himself and his employees every other
week (bi-weekly). When a customer places an order for a piece of
furniture, John receives a 10 percent down payment of the total
sales price. The customer is then billed for the remainder of
the sale after the furniture is completed and delivered.
The total sales price of a recently ordered dining room set
is $10,000. The material needed for this job is priced at $2,500
and will come from one supplier. This supplier offers a 2
percent discount if John pays for the supplies within 10 days
after receiving them. John always takes advantage of early
payment discounts.
The following graphic, illustrating the cash flow effects of
the sale from start to finish, will help you identify John's
cash flow gap. (Click on each of the blue or yellow bars to see
a detailed explanation of business events affecting John's cash
flow each week.)
Breaking down the sale of the dining room set, and tracing it
step-by-step through the cash flow, identifies John's cash flow
gap. In John's case, a cash flow gap starts on day 13 and
continues to grow, reaching $4,450 just prior to collecting the
customer's account. Although this example has been simplified,
it's typical of the cash flow gap that occurs in many small
businesses.
The cash flow gap creates the need for effective cash
flow management. Effective cash flow management can help
reduce the amount of time between John's cash inflows and cash
outflows. This in turn, will help reduce or close John's cash
flow gaps.
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