Mastering your money game can totally transform your life
Why Cashflow is King or Queen:
Understanding the Importance of Financial Health
When it comes to running a successful business, many small business owners tend to focus on increasing sales and maximising profits. While these are certainly important factors in determining the success of a business, there is one aspect that often gets overlooked – cashflow.
Cashflow refers to the movement of money in and out of a business, and it is often considered the lifeblood of a business. In simple terms, having positive cashflow means that more money is coming into the business than going out, while negative cashflow indicates the opposite.
But why is cashflow so important?
Why should small business owners prioritise it over sales or profit?
The answer lies in the fact that even businesses with high sales and profits can struggle if their cashflow is not properly managed.
Let’s take a closer look at why cashflow should be king or queen in the world of business.
One of the main reasons why cashflow is often overlooked is because it can be confused with profit. While both are important measures of financial health, they are not interchangeable.
Profit is the amount of money left over after all expenses have been paid, while cashflow is concerned with the actual movement of money in and out of the bank account. This means that a company can be profitable, but still have poor cashflow if their expenses are high or they have trouble collecting payments from customers.
Let’s show this in an example.
Your business has sold $10,000 in goods to John Jones. This will be shown as a sale on your Profit and Loss Statement, but Mr Jones has not yet paid you as his business has a 30 day account.
As the money has not been collected this has no effect on your cashflow even though it will be reflected as part of your Profit.
Until Mr Jones pays for the goods that he has received, your business does not have the cash to pay its expenses or purchase goods to replace those sold to Mr Jones.
You are now cashflow negative.
And what happens to your cashflow if Mr Jones doesn’t pay on time or at all?
Conversely, a company may have negative profits but positive cashflow if they have a good amount of cash on hand and are able to manage their expenses effectively.
Another key aspect to consider when discussing cashflow is liquidity. This refers to the ability of a business to quickly access liquid assets (such as cash) in order to meet financial obligations.
Having positive cashflow not only allows a company to cover its day-to-day expenses, but it also ensures that they have enough liquidity to handle unexpected emergencies or opportunities. This can be especially important for small businesses, which may not have access to lines of credit or other sources of funding.
Sales and profits are important indicators of a business’s performance, but they don’t directly reflect the immediate availability of cash.
Sales are the total amount of goods or services sold, and profit is what remains after subtracting all expenses from the total revenue. However, these figures do not necessarily indicate the presence of liquid cash in the business.
A business might close a significant sale but if the payment terms are 90 days, it won’t see that cash for three months. During this period, the business still needs cash to operate. Profit doesn’t pay bills – cash does.
Focusing on cashflow over sales and profit can also position a business for future growth. By managing cashflow effectively, a business can ensure that it has the resources to invest in new opportunities, buying inventory at a discount or expand their operations.
Strong cashflow positions a business to take advantage of opportunities. Having cash available can be a game-changer.
On the other hand, businesses that prioritise sales or profit over cashflow may find themselves in a tight spot when it comes to taking advantage of growth opportunities. This can lead to missed chances for expansion and development, ultimately hindering the long-term success of the business.
Businesses with solid cashflow are more attractive to lenders and investors. They demonstrate the ability to meet financial obligations and are therefore considered lower risk.
In challenging economic periods, cashflow becomes critical.
Businesses with a strong cashflow are better equipped to weather downturns without resorting to heavy borrowing or making drastic cuts.
Focusing solely on sales and profit while neglecting cashflow can lead to serious problems:
Cashflow Crunch
Even profitable businesses can find themselves in trouble if their expenses come due before their revenues materialise. This cashflow crunch can lead to missed opportunities and stunted growth.
Increased Borrowing
Lack of cashflow often forces businesses to borrow more, leading to increased debt and interest expenses.
Operational Inefficiencies Without a clear understanding of cashflow, businesses may not realise they’re spending cash inefficiently, leading to waste and reduced profitability.
To keep the lifeblood of the business flowing, effective cashflow management is essential. This includes:
Timely Invoicing and Collections: Ensuring invoices are sent promptly and that there are efficient systems for collecting payments.
Managing Payables: Balancing when to pay suppliers without straining the cash reserves.
Forecasting: Regularly projecting future cashflows to identify potential shortfalls in advance.
Cost Control: Monitoring and controlling expenses to prevent cash leakage.
While sales and profit are important indicators of success, they don’t tell the whole story.
Cashflow is the true king or queen in the business world.
It’s the most accurate indicator of a business’s health and its ability to sustain operations, invest, grow, and navigate through tough times.
Business owners who prioritise and manage their cashflow effectively are the ones most likely to lead their businesses to long-term success and stability.