“Cash is King.” We hear this phrase time and time again, but why is it so important for small and mid-size businesses? The short answer – if you run out of cash, your business fails. Seems obvious, right? However, what may not be as obvious is that being profitable is not the same thing as being cash flow positive. In fact, many businesses that show profitability within their financial statements have ended up in bankruptcy because the amount of cash coming in does not exceed the amount of cash going out.
As an example, consider a service company that just started with a new customer. In January, the company provides the service and invoices the customer on January 31st. The company recognizes the revenue from that customer in January, but probably does not collect the cash until February or March. Meanwhile the company had to pay its’ employees on January 15th and the 31st. Thus cash outflow exceeded cash inflow in January. When you multiply this scenario by hundreds of customers, or consider a month with significant customer growth, you can see how the company could run into cash flow issues.
If a company cannot balance the cash inflows with the proper cash outflows then their profits on paper or supposed net-income are meaningless. Firms must exercise good cash management otherwise they may not be able to make the investments needed to compete, or might have to pay more to borrow the money they need to function.
What the Experts Say About Cash Management
Several industry leaders and associations have all found that cash flow problems can be one of the leading causes of failure for businesses…
82% of businesses fail due to poor cash flow management / poor understanding of cash flow.
— Jessie Hagen of US Bank
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. Poor cash flow management is causing more business failures today than ever before.
— Philip Campbell, author of Never Run Out of Cash (Grow & Succeed Publishing 2004)
Insufficient capital is one of the main reasons for small business failure, coupled with lack of experience, poor location, poor inventory management and over-investment in fixed assets.
— U.S. Small Business Association (SBA)
A Case Study: Importance of Monitoring & Analyzing Cash Flow
One of our clients, a media company, believed they needed a significant capital infusion to support their growth plans, but were uncertain when and how much capital would be required. So we generated a detailed five year cash flow projection to forecast and identify all the time periods in which the company’s cash balance would become negative.
Analyzing the company’s cash flow projections revealed that they would require additional capital even after reaching profitability which is actually typical for early-stage companies, or companies in a high-growth mode. The projections also revealed that the amount of capital required to remain cash flow positive was 50 percent higher than they had initially anticipated.
Knowing their true capital needs allowed the company to raise the appropriate amount of capital required to support their growth plans and, more importantly, ensured they would not run out of cash.
Monitoring Cash Flow for Your Business
Achieving a positive cash flow does not come by chance. You have to work at it. Companies need to analyze and manage their cash flow to more effectively control the inflow and outflow of cash. The Small Business Association recommends monitoring cash flow on a monthly basis to make sure you have enough cash to cover your obligations in the coming month.
By proactively getting in front of your future cash needs, you can make the right business decisions to solidify your cash position, and establish a foundation for growth.
We Can Help
The process of creating and managing to an operating cash flow budget is not intuitive or easy for most small and mid-size business owners. If you need assistance managing your company’s cash flows, developing detailed financial projections, or identifying capital requirements, contact Signature Analytics today for a free consultation.