Cash flow: Why so important to business?
Like the body needs food so a business needs cash to live.
With our body we work or we enjoy ourselves and we carry out many other activities, but it is food that powers the body.
Similarly a business may have many objectives, but it is cash which makes it possible to achieve those objectives. This is why cash is so important to a business; without cash a business cannot survive long.
Why is cash-flow important?
- It provides liquidity. If I sell something on credit to you I have made a profit, but until you pay me I have no cash. If in the meantime I need to pay my suppliers I will have a negative cash-flow.
- Being paid on time means that I can pay my suppliers promptly. Being put on stop can cause major problems to a client who needs the job done.
- It will enable the business to meet its tax liabilities on time.
- It will reduce costs, for example interest charges.
- Having a positive cash-flow provides a feel-good factor; it keeps you in control and makes it possible to plan thus avoiding rushed decisions.
- In the long term a positive cash-flow results in a good reputation for the business.
- It protects the wider economy. If small businesses go out of business larger ones will be affected.
Some important factors to keep in mind
Everything affects cash-flow: people you choose to work with, marketing channels used, pricing & margins. I may get my costing right for one product, but how many do I need to sell in order to break-even?
Every activity has a cost – networking, social media, marketing, development, coming to an exhibition.
The type of clients you are dealing with will affect cash-flow. Not all clients are the same. Employing a lot of resources for a very demanding client is like ploughing rocky soil, which does not produce good results. Therefore cultivate your business relationship with good clients or discuss the problem with those clients who are very absorbing, they may not realise they are having a negative impact.
Is one client too big, perhaps generating 80% of sales? If all your food came from one field and that field got destroyed you would have a problem. Similarly a business that relies on one client only is in danger.
Choose the right location, initially it may be best to work from home. Also consider developing an on-line communication system which is cheaper then always meeting your clients face to face.
Always ask yourself: “How will this decision or this activity affect my cash-flow?”
Controlling your cash-flow.
- Prepare a budget to plan your business growth, but build a cash-flow projection to know what your cash position will be over time. This is what we may call a medium-term or even a long-term projection. If the projection shows that your business needs a loan or an overdraft or money is needed from investors always ask when the sun is shining.
- It is important to realise that profit is not cash. It is good practice to have a short-term cash-flow and update it on a weekly basis. If a pressure point is building who will be filling the gap? Speak to your suppliers to see whether they can provide more favourable terms. Or speak to your clients to see whether they can make an early payment, but don’t wait for things just to happen. As a business owner, you may have to inject some cash, at least for the short-term to deal with the negative cash-flow. Are you prepared to do that?
- Keep an eye on over-trading. A business that is growing too fast may not be able to control its cash position. If the owner cannot fill the gap when cash is needed to pay suppliers or for other commitments, who will?
- Understand what your financial statements don’t say. For example, how to cost a product/service effectively or which market is making the biggest contribution to your cash-flow.
- Finally, improve profits not just turnover. A sales-driven business with a large order book which does not improve its profitability has a greater risk of going out of business than one with limited but profitable work.
- Send a Credit Application to all clients – This evidence will stand up in Court.
- Understand your clients’ procedures for payment. Don’t give more credit than necessary.
- Get paid by direct debit, standing order or credit card. These are good cash-flow techniques.
- Start chasing immediately. Use a 3rd party to collect the debt if necessary
- Discuss a negative situation with your clients to improve business terms.
- Don’t tie up your cash in stock. Even properties may not be a good investment if cash is needed.
- Keep cash available for contingency (up to 10% of your turnover if you can) and tax.
- Monitor your cash on a weekly basis.
- And the most important decision of all: Get a good accountant.