The importance of being solvent…. Or Cash is King!
Posted on 09 February 2010
You must have heard these well worn sayings… "Cash is
king." … and "Happiness is a positive cash flow." Surveys are
conducted constantly on failed businesses and whilst the results
vary, there is a common theme that the majority of failed
businesses (up to two thirds in fact) say that all or most of their
failure was due to cash flow problems.
If you don't believe the maxim that "Nothing matters more than
cash" then you could be skating on thin ice! Making a profit
is nice, cash flow is vital for survival. Cash is the life
blood of any business. Cash management is the key to business
success.
Start-up businesses often find themselves short of cash right at
the outset, whilst existing businesses can find ways to survive if
they can find ways to generate cash. Cash is the single most
important element of survival for a small business. How often do
you hear small businesses say that poor cash control is their
single biggest problem?
A Matter of Timing: Cash vs. Profit
I know you probably already know this - but it's very important to
understand that cash flow and profit are not the same thing.
Financial accounting isn't focused on cash flow... It is focused on
net income or profit. Over the long term, profit and cash flow are
approximately the same but the crucial difference is timing.
Timing can be so important for a small business. For example, when
you make a sale to a credit customer, you recognize that sale
immediately on your income statement (so it impacts on your
profit). That's called accrual accounting. However, you don't
get the money immediately - that usually happens later when you
actually receive payment.
You can see how the gap between profit and cash flow could be
huge. If you have rapid growth in credit sales, for example, profit
could far exceed actual cash received. This sort of situation makes
smaller companies very vulnerable to running out of cash.
Keeping Track of your Liquidity…
You often hear the word liquidity used in combination with cash
management. Liquidity is simply a firm's ability to pay its
short-term debt obligations - its creditors.
There are relatively easy methods you can use to measure your
liquidity. We're not going to get overly complex here, but
using a simple bit of financial ratio analysis will help you keep
an eye on your ability to meet short term payments.
One good measure is the Quick Ratio - it shows whether you can pay
your short-term debt obligations (or your current
liabilities). It basically shows whether your current assets
- that is your cash in the bank or any other cash assets you may
have - are sufficient to meet your short term payment obligations
(your current liabilities). Sounds simple - and it is - but
you'd be surprised at how few businesses take this sort of
view. Do you?
I'd recommend that every business prepares a cash flow forecast to
anticipate and manage your cash requirements over a period of
months. That way there are no surprises!
So - how do you maximise your Cash Flow?
Simply put your aim, as the owner and manager of your company, is
to squeeze all the cash out of your balance sheet that you can. Not
only do you want to get as much cash out of your company as you
can, you want to keep it out in case of a potential or actual
crisis.
There are two main categories of current assets that are the
biggest reservoirs of your cash. They are stock (or
inventory) and debtors (or accounts receivable). Inventory is the
products you sell and debtors represent the credit you extend to
your customers. The balances in both these areas need to be
minimised and converted to cash as soon as possible.
Another short-term strategy to squeeze money out of your balance
sheet is to look at what you owe your suppliers. .Pay your bills on
the day they are due - NEVER EARLY! There is no reason to
give your suppliers the use of your cash days before it is due.
Your business needs to have use of that cash. Stretch out the use
of your funds.
Some tips for good cash management…
• Measure your inventory levels
• Keep them as low as possible without damaging the
business
• Pay your suppliers on time - never before
• Negotiate extended payment terms with your suppliers -
never just take them!
• Vigorously pursue all money owed to you - it's yours by
right… and in law!
• Forecast your cash requirements - avoid surprises
• Know the difference between profit and cash flow
Remember the other old adage… "Profit is vanity… cashflow is
sanity!" Stay sane!
If this article has prompted you to look into some of these areas
in you business you may like to have a no obligations meeting with
an Ology Coach to discuss the challenges you face right now in your
business and how we can help you transform your business
performance. Give us a call or visit the website www.ologycoaching.com .
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