Understanding Cashflows in Business … A guide to business liquidity and growth

There is the popular saying in business that “cash is king” and if that is anything to go by, then cashflow will be considered as the oil that keeps the vehicle engine (i.e. business) running. To grow and sustain business, cashflow is one of the integral tool which cannot be underscored because without cash profit is basically meaningless as many profitable businesses have ended up in bankruptcy because the cash inflows does not compare with cash outflows. Firms that don’t exercise good cash management may not be able to make the investments needed to compete, or they may have to pay more to borrow money to function.

“Despite the fact that cash is the lifeblood of a business – the fuel that keeps the engine running – most business owners don’t truly have a handle on their cash flow,” says Philip Campbell, the author of Never Run Out of Cash (Grow & Succeed Publishing 2004).

Cashflow is basically the movement of cash in and out of a business whiles cashflow management is how one directs or tracks the movement of cash in and out of the business.  A cashflow could be positive (i.e. where cash coming into business exceeds cash leaving business) or negative (i.e. where cash leaving business far exceeds cash coming into business). And to grow and sustain business, managers need to understand cashflows and manage it effectively because If high profits do not translate into more cashflows, then that is likened to seeing lots of fish in a pond, yet not being able to catch any. Cashflow is categorised as below:

Operating Cash Flows – cash flows related to sales (income) and business expenditures i.e. operating activities that generate cash inflows and outflows through the sale of your company’s products and services and the purchase of raw material supplies and other general day-to-day business expenditures. The operating cash flow reflects a summary of daily activities of your business and ultimately its health.

Investing Cashflows – generation of cash flows from activities that relates to the purchase and sales of fixed assets (for instance, property, plant or equipment).

Financing Cashflows – generate cash flows through the investment of money into the business by the owners or lenders. Bank loans, Credit as well as principal repayment of such loans are classified as financing cash flows, however, interest payment of loans is classified as an operating activity. Increase or decrease in owners’ capital in business creates changes in equity and these movements are also associated with financing activities.

Signs of Poor Cashflow Management

The day a business loses focus on its cashflow management is the day the business starts to collapse. It is sometimes difficult to tell when cashflow management is weak but a look out for warning signs such as below could help;

  • decreased liquidity – running out of working capital
  • overtrading – turning inventories faster than trade averages
  • excessive short – term debt
  • missing discounts – payables over terms
  • slow collections – outstanding receivables piling up 

Effects of Poor Cashflow Management

A business financial performance could be affected by poor cash flow management as well as the non-financial cost of poor cash flow and the effects may include:

Missed opportunities – Poor cash flow may cause a business to miss great business and investment opportunities which could have the potential to make production more efficient, increase sales or attract investors.

Diminished competitive advantage – Inadequate or poor cash flow erodes the competitive advantage of a business as it cannot finance the requisite operational strategies to achieve competitive edge over its competitors.

Restricted Growth – Business growth prospects will all go down the drain due to inadequate cashflow or resources to support that growth.

Threatened existence – Negative cash flow threatens the very existence of your business as the business could become insolvent when it lacks the capacity to meet its payment obligations which could eventually collapse the business.

Poor relationships with suppliers – Increasing default in payment to suppliers may cause tension in your relationship with them or end the relationship altogether.

Increased interest and bank charges – The need to secure external funding could come with extra cost which will affect your profit and cash flow. Unpaid bank fees and interest can accumulate very quickly and increase your financial burden as well.

How to Manage Cashflow to Ensure Business Continuity and Growth
Some recommended practical steps to better manage cash flow to ensure business growth include:

Balance the trade-off between payables and receivables – To manage cash flow in trading, it is necessary that a balance is strike between the collection of receivables and the payment of suppliers particularly in setting up credit terms. For instance, where it takes like 21 days to collect receivables but 14 days to pay suppliers, then a business is likely to run into serious cash flow problems. At any possible best, collection period for receivables should be shorter than collection period for the payment of suppliers. In this way, a business is always able to meet its payment obligation as it falls due with surplus for other productive activities.

Tightening credit requirements – Businesses often do give credit to customers, particularly when starting up or growing but this must be done based on customers risk profiling and capability, with” wholesale” credit discouraged. If possible design a checklist to ensure that customers merit credit. Where customers are extended credit, ensure that payment are made promptly, and defaulters monitored.

Increasing sales – If you need more cash, then it obviously suggests you need to attract new customers or sell more to your existing customers. Yes, this may be easier said than done but new customer acquisition is critical to growing business and it can some time and money to translate the prospects into sales. Selling more to existing customers is relatively cheaper and may have to do some analysis on things like what they’re buying and why. Such information may even lead you to increase your profit margin and/or generate more cash, but caution must be taken not to increase account receivables in the attempt to increase sales because of its cash flow implications.

Pricing discounts – To reduce increasing account receivables and increase cash flow, one option to consider is to offer trade discounts for prompt payments. The good about this practice is that, it will impact profit margin and help manage cash flow as customers are incentivized to make payments earlier than normal billing cycles.

Securing loans – Business may also opt for short terms to manage short-term cash flow problems, if the situation so allows for such. You could opt for loans like revolving credit lines or equity loans or a long-term amortized loan which includes interest and principal until the loan is paid off but note that, the borrowed funds must be used for only for activities that have the potential to generate cashflows.

  • Cash flow tracking or monitoring – Periodic tracking and monitoring of cash flow is also necessary to determine if the business is creating the type of cash flow to grow. This also helps to develop reliable cash flow forecasts to make business decisions with regards to expanding the business and meeting payment obligations.

Conclusion
If you ever think growth is the antidote for cash flow problems, then you must revise your notes because businesses that held the same assumption later realized that their increasing goal of growing business without reference to cashflow resulted in the worsening of their cashflow problems. As you plan for growth, do same for related cashflows to avoid surprises.
About the Author

A Financial, Audit and Tax Consultant at Danisa Consult (Accounting, Audit & Tax) and a Facilitator for Accounting, Tax and Audit at Global Institute of Resource Development (GiRD), a Capacity Development and Training Institution.

Comments and suggestions to dajdesmond1@gmail.com /0242844114