How customers pay and how quickly they pay changes cash needs. Diligence checks billing terms, receivables and working capital, not only revenue and profit.
10 min read · Level 3
I think every financial review of a growing company should put revenue and cash collected on the same chart. When the two lines separate, something is happening - longer terms, unhappy customers or optimistic recognition - and the income statement alone will not tell you which.
Revenue is recorded when earned; cash arrives when customers pay. The gap can be large.
Billing terms.
Annual contract of 120,000 billed upfront cash arrives at the start The same contract billed monthly 10,000 a month Billed quarterly in arrears, 60-day terms first cash about five months in
Days sales outstanding (DSO) measures how long customers take to pay:
DSO = accounts receivable / annual revenue x 365
Receivables 500,000, annual revenue 2,000,000 DSO = 500,000 / 2,000,000 x 365 = about 91 days
At 91 days, roughly a quarter of a year's revenue is waiting to be collected at any moment.
Warning signs:
DSO rising over time Large receivables from a few customers Old receivables that may never be collected Revenue growing faster than cash collected
Because runway is about cash, not revenue. A company can grow revenue quickly, extend payment terms to win customers, and run out of money while its income statement looks healthy.
Rising DSO can also signal customer dissatisfaction or aggressive revenue recognition.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
DSO rising over a year.
Quarter Annualised revenue Receivables DSO Q1 1,600,000 240,000 about 55 days Q4 2,000,000 500,000 about 91 days
240,000 / 1,600,000 x 365 is about 55. Revenue grew 25%; receivables more than doubled. At Q1's DSO of 55 days, Q4 receivables would be about 300,000. The extra 200,000 is cash the company has earned on paper but not received, equivalent to a full month of its 200,000 net burn.
Looking at revenue growth without checking whether cash collection is keeping pace.
Check whether customers pay upfront, monthly or in arrears.
Track whether customers are taking longer to pay.
Identify old or concentrated unpaid amounts.
Confirm cash is growing alongside revenue.
During diligence on companies selling to businesses or on credit terms.
Do not apply the same expectations to consumer subscriptions paid by card, where receivables are usually minimal.
Small business and accounting research frequently identifies cash flow problems, rather than lack of sales, as a leading cause of business failure, particularly for companies growing quickly on credit terms.
Profitable growth on paper can still exhaust cash. Watch receivables as closely as revenue.
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