Having worked with small to medium-sized enterprises (SMEs) for over 30 years, most recently as CEO of MACHUS Solutions, I have been privileged to provide advice to clients in almost every industry including retail, education, construction, steel fabrication and even hospitality. By working with all kinds of SMEs, ranging from sole traders to multi-site operations, I have unfortunately witnessed a lot of business failures.
There have been various reasons for this including trading losses, inadequate training and lack of capital. However, most business failures have nearly always come down to one thing, poor cash flow. The worst part has been, in most cases, the business owners weren’t even aware of the cash shortages until it was too late. This is because they had a very profitable business but with liquidity problems.
Why is cash flow so important?
Cash flow is the lifeblood of any business. Without it, a business won’t survive. It is used to determine the liquidity position of a business and it helps to assess its current value. Cash flow is crucial for determining the current situation of a business and it states whether a company has the ability to meet its financial obligations as they become due for payment. If a business is unable to do so, it is said to lack liquidity and could be deemed insolvent.
What is cash flow?
The short answer is, cash flow is the amount of money flowing into a business less money going out. Think of it like a bath tub. The tub fills up with water but drains once the plug is removed. The movement of the water is the bath’s water flow. If that water were money, the movement would be the cash flow. Businesses therefore need to ensure their baths remain nice and full.
Cash flow is composed of:
- Cash inflows (or money flowing into a business) which can be generated through the sale of goods and services, sale of assets, loan receipts, investor funding, interest on savings or even investments
- Cash outflows (or money flowing out of a business) which include payments for stock or raw materials, employee salaries, rent, equipment purchases and other operating expenses
Cash flow can further be classified as either positive or negative. Positive cash flow is when a business receives more money than it spends. Positive cash flow means a business is running with cash surpluses. High positive cash flow is even better and allows a business to make new investments, hire more employees, open a new location and ultimately grow.
Negative cash flow, on the other hand, is when a business’s is paying out more money than it has coming in.
A business is profitable. Why should it worry about cash flow?
Cash flow can be difficult to understand when a business is profitable. But I want to be clear, profit does not equal cash. I’ve seen it all too often. A business has an accounting system that produces profit and loss statements and balance sheets every month. However, despite these reports showing a very healthy picture of the business and its financial performance, it is unable to manage its cash position and does not have enough cash to fund the business. In other words, it has negative cash flow.
To illustrate how a business can be profitable yet still become insolvent from cash flow problems, consider a company that pays for its stock in January. Because the stock arrives from overseas, the business won’t get paid by its customers until June. Consequently, it needs a loan to survive until then. If it doesn’t get the loan, even if the sales are guaranteed, the business will likely fail.
What can a business do to improve its cash flow?
I have a great piece of advice for SMEs wanting to improve their cash flow and ensure they stay in business. Start generating regular cash flow projections. In my experience, cash flow projections are one of the key areas that are neglected by SMEs because most new and existing business owners believe them to be unnecessary or complicated.
Whoever is responsible for the financial control of the business, even if the business is very small, needs to make sure they generate cash flow projections for at least three months ahead. It is much easier to deal with a cash short fall if a business knows months in advance that it will happen. There’s very little a business can do if it discovers there is a shortage when it is trying to pay its employees’ salaries or its expenses.
I believe business surprises should always be avoided. So, make your business predictable and successful with regular flow projections.
About the Author
Mac Radomyski is CEO of MACHUS Solutions. He has over 30 years’ experience improving business performance for SME’s and is skilled in all aspects of change management.