What is the cash flow gap? The term refers to the period between when a business pays out expenses (e.g., wages, external services, or cost of goods) to satisfy a customer order or brief and when it receives payment. The bigger the interval between paying out to supply the order and receiving the customer’s payment, the greater the burden on the business.

What Is Cash Flow Gap?

The cash flow gap is the time between paying out expenses to complete the customer’s order and receiving payment for the invoice you sent. For example, the cash flow gap arises when a photographer hires a large-format camera to fulfil their customer’s brief, pays for it on the same day, but receives no payment from the customer for thirty days. The cash flow gap exists between the payment for the camera hire and the customer’s payment. The misalignment between cash inflows and outflows will cause cash flow issues for the photographer’s business.

Cash Flow Gap

Why Is This Important?

Looking at the definition of a cash flow gap – the time between when a business pays out cash to fulfil an order and when it receives payment from the customer – the potential severity of the situation for businesses is clear. When this gap appears with multiple customers, it can be catastrophic for cash flow. The larger and more numerous the incidences of the cash flow gap, the greater the risk of negative cash flow becomes. A business is vulnerable to a cash shortfall if the cash inflows and outflows are unaligned.

The longer a cash gap goes on and the more numerous the incidences are, the greater the risk of the business running out of cash and being unable to cover its operational expenses. Cash flow gaps can significantly impact a business’ ability to meet its obligations, such as payroll and paying its suppliers. Businesses must keep track of cash flow gaps to identify potential issues or opportunities and properly manage finances.

As this situation can create serious problems for businesses when they go uncorrected, the key is to be able to identify cash flow gaps and proactively deal with managing cash flow. Once the business has taken steps to close the gap, it should institute procedures to prevent them from occurring in the future.

Common causes of a cash flow gap

One of the many causes of cash flow gaps, is the time lapse between the completion of a project and receiving payment from the client. For example, the contract or letter of agreement signed with your client did not stipulate a percentage of the fee upfront.

A schedule was in place and attached to the contract. But the client running behind with their deliverables has delayed the project’s progress. However, your client’s delay does not mean that you can delay paying your staff.

Publishers, for example, often deal with the issue of the cash flow gap when authors are late delivering text. To deal effectively with the delays, they may have to pay both in-house staff salaries as well as freelancers’ fees. Their design, printing, and delivery costs may also increase due to the delay. The book’s late arrival on the market and potential loss of sales are likely to impact the publisher’s return. A break-even analysis in this situation would be useful. The analysis is likely to indicate a postponement of the profit-making threshold on this publication, potentially leading to a decrease in profit. You could use the break-even analysis, a small-business accounting process, to calculate unit costs and the costs of delays.

Seasonal fluctuations

Cash flow management is the key to survival for both goods (manufacturing and retail) and services companies (e.g., hospitality and leisure). Holding cash reserves to withstand seasonal fluctuations is the difference between life and death for any company. For example, seasonality in retail, leisure, and hospitality in Australia is a well-known drag on profitability. In these service sectors, businesses may do all they can to employ tactics. Such as seasonal discounts and promotions, holiday-themed product lines, optimisation of online content and design, and marketing campaigns. However, if income is trickling in and outgoings are freely flowing (e.g., for premises, staff, inventory), and you still need to buy in stock for the next busy period, how can you make expenses and incomings align?

Since seasonal fluctuations are known to seriously impact cash flow, cash flow projections can help to predict where cash is going out of your business and when revenue is going to improve the situation. Here’s why tight management of both your accounts payable and accounts receivable is critical to accurately forecasting and making plans to manage them.

If you have cash reserves to support your business through these slow periods, you can manage seasonal cash flow gaps. However, with the help of efficient bookkeeping and accounting practices, proactive debt management, managing your cash flow cycle, and forecasting will preserve the reserves. You will already have planned how to reduce costs and streamline business.

To see into the future, forecasting requires accurate bookkeeping and tight accounts payable and receivable management.

An accountant can help you control your business inventory, which is essential so that the high season can support the low season and ensure that you do not have to raid cash reserves during peak business periods.

Hence, the key to bridging the cash flow gap comes down to the quality of your bookkeeping and accounting. Working capital management, tracking cash and cash needs, is central to managing the company’s cash flow by forecasting inflows and outflows, monitoring cash balances, and optimising cash flows. This is essential to ensuring any business has the liquidity to get through the “dry season”.

Delayed customer payments

Issues with late customer payments are the major cause of cash flow gaps. The delays in invoice payments can be attributed to two factors:

Late payment of invoices often boils down to either not enforcing payment terms or failure to have a payment terms agreement in place from the beginning. Poor accounts payable systems and the lack of an efficient tracking and follow-up system are another reason for late customer payments and poor cash flow.

Extended payment term offerings are one way to attract new customers and show appreciation for existing ones. However, while extended terms can appear to improve revenue short term. The cash flow gaps you’re hoping to avoid can also be created. If you have the systems to manage and monitor extended payment terms, that helps. But if not, you could create a mismatch between accounts receivable and accounts payable, which will become quickly unsustainable.

One way to bridge the cash flow gap here, is to incentivise early payments (with a discount for early payments) and penalise later payers, but this can be more difficult for small businesses working at tight margins.

Unexpected expenses

Unexpected expenses (such as the emergency purchase of faulty equipment) often result in cash flow gaps. Equipment insurance is a legitimate business expense and should form part of your risk-management plan. This plan should include a contingency fund to manage these unexpected events. The contingency should be enough to cover your business operating costs for a quarter or half of the year, since paying for these unexpected outlays could find you grasping blindly for emergency solutions like borrowing money, selling assets, or dipping into personal funds to meet the cost of them.

Overinvestment in inventory

Your inventory turnover ratio refers to stock sold, used, or replaced. Hence, overstocking in a literal sense or overinvestment in your business operating inventory can lead to products that end up being unsold or sold at a discount or goods in your company that are extraneous to its operations. Holding an excess of inventory can cause cash flow problems for companies. Sometimes, if you’ve paid for products that don’t sell or you don’t use, a discount sale can be a good way to generate a quick cash injection. However, overstocking is generally something to avoid. Ideally, businesses will buy in enough inventory to avoid an out-of-stock situation but avoid excess.

Every overstocked item in the inventory is an unplanned cost. Excess inventory can drive storage costs up as well. An inventory manager using inventory management software can help businesses avoid over- or underbuying.

Poor financial planning and forecasting

Good financial planning and forecasting is key to avoiding cash flow problems. Tracking cash inflows and outflows over a specific period helps to identify cash flow gaps and gives insight into where cash flow problems are stemming from.

Good financial planning will outline how your business intends to generate future income and cover future expenses. It will provide an estimation or projection of likely future income or revenue and expenses.

In these uncertain times, both are critical to managing cash flow and avoiding the gaps. If your business lacks a cash flow buffer or if the cash flow gaps are unidentified and beginning to build up, it’s doubtful you will be able to mitigate disruptions or compete on the market, whatever industry your business operates in.

Businesses, whether start-ups or established, small, medium, or large, cannot manage cash flow gaps without financial planning and efficient cash flow forecasting. Underestimated costs, overspending, and inefficient resource allocation tend to add up simply because of poor debt management.

However, the good news is that issues relating to cash flow, poor debt management, issues in accounts payable, and poor financial planning and forecasting tend to be something that can be improved by outsourcing to a reputable bookkeeping and accounting outsourcing service company.

High fixed costs

Every business has overheads, but the size of these varies. High fixed costs (premises, staff, storage facilities, transportation, etc.) can eat into your cash flow. It can be worthwhile hiring an expert to investigate ways to reduce fixed costs. Moving premises or negotiating a lower lease or rent, reducing staffing costs, looking at utility providers and transport logistics expenses, changing suppliers, and analysing unnecessary expenses overall will help to reduce the cash flow gaps.

How To Identify Cash Flow Gaps

f a cash flow gap is the time between paying for something and getting money in return, how can you go about identifying the cash flow gaps? This equation can be used to identify the cash flow gaps:

Receivables period + Days in inventory (-) Payables period = cash flow gap in days.

[Divide all of these by either 365 for an annual figure or 30 for a monthly figure.]

Days receivable is the average number of days your customers take to pay you. Divide your accounts receivable (the money your business is owed) by your average daily sales. This relates directly to good accounts receivable management. Delays in payments from your customers have the potential to cause an imbalance against “days payable”; in other words, payment delays by your customers are one of the direct causes of cash flow gaps.

Days inventory your inventory turnover is calculated by dividing the cost of sales per day by the average inventory. This refers to the average time it takes your business to turn its stock or inventory into sales. A higher inventory ratio tends to indicate stronger sales; a lower one indicates weaker sales.

Days payable refers to the average number of days it takes you to pay your creditors or suppliers for stock. Take your accounts payable (your business’s debt) and divide it by your average daily purchase. Paying your suppliers slowly is not always the best option; you may be able to reduce expenditure by paying them faster. And you could try a similar strategy with your own customers to mitigate the risk of slow-paying customers creating a cash flow gap.

How To Improve The Cash Flow Gap

  1. Don’t be tempted to overstock or buy unnecessary items.
  2. Don’t agree to short payment terms from suppliers; pay your suppliers on time; negotiate discounts for fast payment.
  3. Issue invoices promptly, as soon as a job or project is complete (or according to the terms of your letter of agreement or contract). Avoid exceeding the scope of projects and thereby creating fees leakage.
  4. Give customers no excuses for late payment. Make it easy by putting your bank account information on your invoice and stating your terms.

Building a buffer

All businesses experience cash shortfalls occasionally. If you can build cash reserves, you’ll always have a buffer when things are lean. As a reserve aim to cover three to six months’ expenses. Reviewing your cash flow allows you to estimate how much money to put aside as a buffer.

Attending to cash flow

Reviewing and monitoring cash flow enables you to close your cash flow gap. Working capital management looks at your short-term liabilities against your assets. Healthy cash flow is attainable when you know what’s coming in and going out. If you don’t know, you can’t plan your cash flow gap strategy. Many cloud bookkeeping and accounting software applications can automatically perform a cash flow analysis on your data.

Monitoring and reviewing strategies

The cash flow gap is a constant risk that you need to monitor, review, and adjust. Spend around 20 minutes a month tracking your cash flow and regularly reviewing your strategies. Make the necessary adjustments to ensure your business is right on track.

Taking decisive action

Even if the gap is big, decide how you’re going to alleviate the situation. Don’t risk your business running out of cash to pay suppliers or creditors, as this could negatively impact your reputation and affect your credit score. You could ask for time to pay as a last resort, but only if you act now and communicate.

Facing up to your finances

Having identified a gap, we can now act proactively. Plan to stay on top of your finances and exploit the power that being aware of your cash flow gives you.

Raising funds

While borrowing may appear to be one of the quickest ways to close the cash flow gap, avoid this option if you can. Using credit cards to inject cash into your business is not a good idea, either. Seeking the expert advice of a qualified accountant is the most beneficial option before you resort to maxing out credit cards or applying for a loan.

Reducing expenses

Reducing business overhead costs is the best and most immediate way to reduce the cash flow gap. If you can do this, more money stays in the business. To find cash flow solutions, review your fixed and variable costs. Is it possible to contact your suppliers to negotiate better rates or ask for time to pay? Taking a proactive approach is better than going on the defensive when the bill is overdue. Review your suppliers: are there any that could provide you with better terms, or could you change suppliers?

Consider Outsourcing To Bridge The Cash Flow Gaps

Every business should seek to make its cash flow gap as small as possible. The smaller the gap on current financial statements the more consistent the cash flow. 

Cash flow forecasting by a professional to help businesses manage cash flow is a frequently ignored area of running a business profitably. It might appear to increase business overhead costs, but it will be more likely to reduce them. 

You can outsource credit control to Outbooks, whose efficient teams are performing credit management processes every day, will quickly deliver efficiencies that will close your cash flow gap. 

Hinakshi Nihalani
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Hinakshi, a Content Writer and Social Media Expert at Outbooks, brings her passion for writing to every project. Specializing in tax preparation, management accounts, cash flow, and VAT returns, she creates engaging, well-researched content that simplifies complex topics. Her work supports accountants in growing their practices and optimizing finances, making valuable information accessible to professionals and newcomers alike.