In this article I’m going to explain why cash and cash flow are very important.
What Are Cash And Cash Flow?
When businessmen and bankers talk about cash they are generally referring to your bank balance rather than what’s in your petty cash tin.
Cash (and bank) balance is a snapshot picture at a moment in time that you will see on your Balance Sheet.
Cash flow is the movement between two balances during a period of time. A cash inflow means that you get more in than you pay out, an outflow means that you’ve paid out more than you’ve received.
A Short Cash Flow Example For One Week
Here is a small example to help you to understand the ups and downs and the limitations of the different measures.
Balance at start of the day 1 = £5,000
Cash flow during day 1 = £3,000 (inflow)
Balance at the end of the day 1 = £8,000 (this is also the balance at the start of Day 2)
Cash flow during day 2 = -£7,000 (outflow)
Balance at the end of the day 2 = £1,000
Cash flow during day 3 = -£4,000 (inflow)
Balance at the end of the day 3 = £5,000
Cash flow during day 4 = -£2,000 (outflow)
Balance at the end of the day 4 = £3,000
Cash flow during day 5 = £4,000 (inflow)
Balance at the end of day 5 = £7,000
We’ll assume the working week only has five days.
While cash has gone up and down, over the week, the balance has increased from £5,000 to £7,000, a net cash inflow of £2,000.
The cash balance gives you an indication of how much you can afford to pay out now but doesn’t give you much indication of how much you can afford to pay tomorrow.
That’s why cash flow forecasts for future movements are important together with what you believe the balance will be at the end of the period.
This business pay have to pay £15,000 of salaries at the end of next week. Should it be holding back other payments?
Think About Cash Flow During Business Start-Ups
If you’re thinking about starting a business and you’ve read a few books on that subject and business planning, you’ll have noticed the remorseless emphasis on slogans like “Think Cash First” and “Cash Is King”.
You may disagree and think your top priorities are finding the products you want to sell (or designing the services) and learning how to sell effectively so you get your first customers.
You’re right and wrong.
They are essential if your business is going to get off the ground successfully but I want you to think about cash and your cash flow while you’re doing these things.
The decisions you take and the negotiations you agree to over cash payment terms could be the pivot your business depends on. get it right and you succeed. get it wrong and you’ll condemn yourself to failure.
Why Cash Flow And The Cash Balance Are Important
Businesses fail because they make bad decisions over cash and pay too little attention to managing cash flow.
In the cash flow example for the week, I posed a hypothetical question about how the business pays £15,000 of salaries at the end of the next week when it only has a cash and bank balance of £7,000.
Making payroll if a very common of business owners who are struggling on the breadline and living hand to mouth.
If the business is confident it will get a net cash inflow of £15,000 in the next seven days (perhaps because several large customers are due to pay and their payments are reliable), it made sensible decisions this week.
But if the businesses isn’t confident about getting plenty of money in, then the decisions made this week are open to question:
- Could it have delayed payments to suppliers made in the current week?
- Could it have been more active chasing up receipts from customers this week so that it knows there are plenty of promises of payment for next week?
- Could it have made a special offer to customers to get a price discount for immediate payment before delivery or on delivery?
- Could it have seen the bank manager and negotiated an overdraft?
- Could it have even started negotiations with the staff for a delayed salary payment, with an interim payment of enough to stop employees to having their own financial problems with missed mortgage payments and rent arrears, no money to buy food etc.
Can you see how, when things get tight, cash and cash flow goes from being something you don’t thing about enough to the only thing that matters?
It’s Easier To Avoid A Cash Flow Problem Than To Get Out Of It
The truth is that it is much easier to avoid digging the cash flow hole than it try to claw yourself out of it each week or month to make critical payments.
Think cash flow in everything you.
How can you:
- Get more cash inflows and speed up the money that customers will pay you?
- Make fewer cash payments and slow down what you have to pay to suppliers and employees?
A business start-up can get so excited about the chance of making a sale with a big company and the opportunity for regular ongoing sales, that it doesn’t think about the bank balance and cash flow can miss the small print in the agreement – “payment will be made 120 days after the goods are delivered.”
Double ouch if suppliers insist on payment with the order because the business is new and doesn’t have any kind of track record or payment history.
If there is likely to be a problem, it’s easier to have a few weeks to think about solving it than having to deal with a cash crisis on the day it happens.
That’s why cash flow forecasts are essential for every business that has a cash issue or wants to avoid a cash flow problem in the future.
Profit vs Cash Flow
I’ll write another article about the difference between profit and cash flow.
At this stage, know that businesses can be profitable and have negative cash flows.
These are vulnerable and can run out of money.
When there’s no cash, in the end, there is no business.
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