So let’s look more closely at that second row, and how it’s calculated. The numbers here are in the background. They don’t show up on a standard cash flow statement, but they are critical calculations.

Remember: if you get paid immediately by your customers, by cash or credit card, you don’t have to worry as much about this. If, however, you’re selling to businesses, then this is really important. Unless you’re really unusual, with business-to-business sales, you deliver invoices to your business customers and you then have to wait for them to pay you. You get into a balance situation, in which they don’t want to tip the balance by waiting too long, and you don’t want to tip the balance by insisting too hard. It’s quite common.

Those Critical Assumptions
  1. Accountants normally figure collection days after the fact, using your sales on credit and average balances. With algebra, you can calculate in reverse. For example, if I know I’m selling $35,000 per month on credit, and I have 60 days of collection days, then my balance should be about $70,000.
  2. Not all of your sales are on credit. Some customers, even business customers, will pay cash. You might have a mix of consumers who pay cash and businesses that wait to pay. So you have an assumption of percent of sales on credit.

You deal with this with assumptions. In the illustration here you’ll see an assumption for estimated collection period in days, meaning how many days, on average, you wait to get paid. You also have assumptions for sales on credit as a percent of total sales.

So that all boils down to a row in the illustration here, cash from receivables. That’s the amount that gets into your cash. You can see how this is different from sales. You can also see the flow between last month’s ending balance, this month’s sales on credit, and this month’s ending balance.


The collection days estimator sets the amounts received. (Amounts shown in thousands. Numbers may be affected by rounding.)

Just in case you have any doubt about how that works, take a look at the following illustration with the same numbers except for the change in your estimated collection days. What happens is that the more the estimated collection days, the more of your assets are in receivables, which means, ultimately, less cash. We stated that in cash flow traps: every additional dollar in receivables is a dollar less in cash.

This simple change turns acceptable cash flow into cash problems.

Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.