The Importance of cash flow and why it trumps profits!

The Importance of cash flow

The goal many new businesses focus on when they initially start up is almost always profit. However, whilst the intentions are correct, in that without being a profitable venture the company will not survive within the long term, without considering the importance of cash flow. This is showcased by the expression “cash is king” and encapsulates the idea of how important cash flow is to the survivability of the business.

The difference between cash flow and profit

Firstly understanding the difference between cash flow and profit is crucial; simply put cash flow is the money coming into the business minus all the expenses that have occurred. Whilst profit is recorded when the sale is made, but not necessarily when the money has been received.

What makes cash flow more important that profit?

Within the UK 50% of all new businesses fail within 5 years, a variety of factors are the driving force behind this, but one of the main reasons is that even though the business may be generating a profit, they are unable to meet their short term liabilities. With payables demanding payment, be it the bank or a supplier, they can apply for a court order to wind up and liquidate the company.

Meeting those liabilities

As a business you will encounter initial start-up costs and the need to borrow money, this may be to buy buildings, equipment as well as inventory. Even if you are generating a profit, if you are not receiving the income fast enough, you will find yourself in a situation where creditors are demanding payment or you need to make a loan payment without having the cash available.

This is why cash flow management is extremely important, and regular weekly cash flow forecasts should be made, to be able to plan what bills need to be paid, and what cash will be available to allow you to pay.

Managing your cash flow will also allow you to be more flexible and identify problems before they occur, allowing you to ask for earlier payment from payables if necessary. Being able to see where and why the business may be low on cash allows you to implement an action plan to fix the situation before it happens.

Whilst cash flow is important, don’t neglect the profits

Even though cash flow can put the company in difficulty, the combination of looking after cash and profits are needed to be successful. A balance needs to be struck, as an unprofitable business will fail, as well as a company running out of cash. Therefore, the perfect solution is to plan and track what money is going in and coming out of the business and when. If you are currently in a strong cash position, you may be willing to forgo an early settlement discount to increase profits.

There is a balancing act between the two, with both being important to the survival of business, but with cash flow often being a second thought, it requires the attention and meticulous planning to ensure the long term survivability of the company.