It’s a cliché that cash flow is the lifeblood of every business. However, as with most clichés, it’s a cliché there’s a lot of truth to! Many business owners, particularly those who are just starting out, think that making more sales is always a good thing. Actually, monitoring cash flow is key to understanding why that’s not always the case!
Poor cash flow management can result in a number of different problems. Of those problems, these are a few examples –
- Too much stock – A business owner receives high demand for a product and orders high volume of materials to fill orders. If the demand suddenly changes, the business owner is left with too much stock and, potentially, debts from ordering materials. There’s also the potential risk that the stock you have will become obsolete!
- Long payment terms – Lengthy payment terms often mean long stretches of time go by without money coming in. Any unseen issues, which covers anything from a fire at the office to the need to replace a laptop, can be problematic due to a shortage of cash. There’s also the possibility of bad debt – this is when customers or clients never pay you at all!
- Overspending – It’s very tempting to splash out on orthopaedic chairs and huge monitors for your office, especially after winning a new client. Still, remember that you haven’t actually got that money until they’ve paid you; if you need any cash in the mean time, it’s likely to be very difficult to convert fixed assets back into cash! Not to mention the fact that spending money you don’t actually have is never a good idea…
- Overtrading – In a similar vein to buying in too much stock, it’s tempting to employ more staff, expand to different locations etc when you’re doing well. However, offsetting fixed prices like rents and salaries against profits, which may vary from month to month can be a risky move and can put a lot of pressure on short term finances.
Turnover is vanity, profit is sanity but cash flow is reality
There are a few different variations of the above expression kicking around, but they all highlight the fact that cash flow is, arguably, the most important figure a business can keep track of. The profit a business is usually a business’s most important source of cash, and monitoring those profits (or losses…) is directly linked to cash flow problems.
Cash flow is also useful for a wealth of other reasons, including its use in determining things like the rate of return on particular products or projects – only a fool would ignore it!