WHAT IS CASH FLOW AND WHY CASH IS KING?

 
The phrase “cash is king” is always thrown around in business and rightfully so, but what does it really mean? Well, cash is beyond being king, cash is the very life of your business. Just like humans need oxygen to remain alive, businesses need cash to remain alive. Statistics show that 80% of new businesses fail within their first three years, and the majority fail because of cash flow problems.
 

So what is cash flow?

 
In simple terms, the term relates to the flow of cash in and out of your business. 
You as an individual know what comes in and goes out of your bank account every month. You also know that if nothing comes in, you will struggle to pay for your bills at the end of the month and may resort to your credit card or loans from friends which further worsens your problems.
It’s the same in business if the cash coming in is below the cash going out, the business will encounter problems and eventually fail. 
The comment I often hear from entrepreneurs is that “my business is showing profits, but I have no cash in the bank”. That is because cash and profits do not mean the same thing. Profits are an accounting term and they are good to have, but they do not mean that you do not have cash flow problems. Cash in the bank is more important that good profits on paper, your focus should always be on making sure that your bank balance remains strong.
 

Why should I focus on managing cash flow in my business?

 
If your business does not have cash of its own, it means someone is financing its survival, this could be you, a bank (via overdrafts and loans), your creditors or an investor. It also means that the business is not strong enough to survive on its own. It is absolutely critical then that you as a business owner understand cash flowing in and out of the business and you are able to account for all of it.
Understanding your cash cycle i.e timing of your inflows and outflows is also crucial.  How long it takes to receive money from your customers vs how long you have to pay your suppliers or service providers. If you have to wait longer to receive payments from customers vs the time when you pay for supplies or services then you will most likely encounter cash flow problems.
 

How do I know my business has cash flow issues?

 
You know your business has cash flow issues if you are not able to sleep at night. Seriously though, the following will tell you that there are cash flow issues:

• The business bank balance is negative or close to zero (that’s the most obvious sign)
• The business does not have funds to cover its expenses
• The business struggles to pay for debt as it falls due
• The customer payment terms are significantly generous when compared to negotiated supplier payment terms
• There is a large amount of stock that has not been sold
• Sales are decreasing while costs remain the same

How do I improve cash flow management in the business?

 
Businesses need to apply cash flow management techniques that will ensure that:

• Cash flowing into the business is received as early as possible. If your money is held up in customers, it means you are a bank that issues interest-free loans. The generosity needs to stop as it is at the detriment to your business.
• Cash flowing out of the business is paid out as late as possible. If you have good payment terms with your suppliers then you can actually pay them after you have collected your cash from customers. Make it a habit to build good relations and negotiate better with your suppliers.
• All future spending is carefully planned for and will not cripple the company. 
• Cash is not tied up on stock that has not been sold. Proper stock management can ease a lot of  load on cash flow.
• Unnecessary costs are reduced and the business is run more efficiently.

 
Having more cash in the business alleviates a lot of strain from the business for the business and for you as an entrepreneur. If there is free cash there are opportunities to make more meaningful decisions like negotiating better with suppliers based on upfront payments and funding your own expansion opportunities. Always keep that eye on cash flow and finally accept that cash really is king.
 
At The Accounting Village we can assist cash flow management for your business, if you have any questions or require assistance please feel free to contact us  and we’ll get in touch with you.