Cash is needed to run a business. Cash allows you to pay bills, meet payroll and make capital improvements to fuel expansion. Cash, however, runs out quickly and must be replenished through a steady cash flow if the business is to survive, even in the most prosperous of times. In the new economy, poor cash flow kills businesses.
Cash vs. Cash Flow vs. Profit:
The common experience of getting ready to wash your face provides a simple analogy for these complicated and intertwined financial metrics. Both the tap and the drain represent a cash flow that can be defined as flow in (tap) and flow out (drain). The water that is poured into the sink is analogous to the income that enters the company. For the cash inflow, it doesn’t matter if the product/service was sold at a profit or a loss, just that the revenue flows. Rather, all business expenses, from the electric bill to insurance, payroll, and vendor charges, are accounted for down the drain. Just as water comes out of the sink, the company comes out of cash. The water that accumulates in the sink represents the available cash. Finally, increases (profit) or decreases (losses) in the amount of water in the sink, from one measurable time to another, represent the company’s profit.
So, for example, a business might measure profitability on a monthly, quarterly, and/or annual basis, which means it’s comparing revenue inflows minus expense outflows to determine which was greater over the period. If the receipts were higher, the company was profitable. If outputs were larger, the company operated at a loss.
Every measure of financial achievement is necessary. Additionally, increasing each metric is essential for continued operations and growth.
cash king:
King Cash rules the kingdom. The bigger his company’s stack of cash, the better he can sleep at night. While savings don’t solve problems, they give you something that would otherwise be unattainable: time. If the business is running in the red (not profitable) or cash outflows are greater than inflows (negative cash flow), the cash on hand buys him the time he desperately needs to correct these problems. Both will need to be corrected to survive; cash buys you time to figure out how to turn it around. Ironically, by definition, the cash your company has now came from positive cash flows and profitability at some earlier point in the company’s history. It was carefully compiled each year on the retained earnings line of your balance sheet and stored in your savings account.
In the absence of real cash on hand, the business must resort to debt in times of trouble. Unfortunately, banks and lenders are slow to lend cash to troubled businesses. So if your business is in crisis and you didn’t execute a financial disaster preparedness plan when times were better; there is little you can do other than liquidate the assets. If, on the other hand, all three metrics are high, now is the time to apply for or increase the company’s line of credit. This is best done with a great recently signed contract and the latest expertly printed and bound financial statements.
Queen’s Cash Flow:
King Cash rules the kingdom as its head of state; but Queen Cash Flow is the neck of him. And everyone knows that the neck turns the head. So, assuming your business isn’t cash-rich, the metric that towers above the rest in demand for your attention is cash flow.
Imagine a situation where the company is profitable on paper, meaning that it is selling its goods/services for more than the cost of delivering them; but, the cash is not flowing. This would mean that the revenue is due as Accounts Receivable; yet, it has not reached the door of the firm. How long can a company survive? Assuming the business has no cash on hand and no means to acquire a quick, temporary infusion of cash (line of credit), the question can be answered with another: how long will you and your co-workers continue to work for a business after a payment date has come and gone without payment? Suffice it to say that the demise of the company is measured in weeks, not months or years.
benefit of the prince:
Companies are in business to make a profit, period. Without earnings, there is no growth, and corporate value declines as assets age and depreciate. Earnings, like the Crown Prince, must be treated with respect to prepare for the future. Winnings may be overlooked in extreme situations to satisfy King Cash and Queen Cash Flow. However, if this is done for more than short periods of time, the future of the business is in jeopardy.
Financial metrics are company royalty. Each must be cared for and cultivated. As cash flows increase, cash on hand and earnings also increase over time. Although economic times can be desperate, the rules of corporate finance never change. As complicated as these topics may seem, they can be summed up in a very simple principle that you probably learned growing up: “If Mommy isn’t happy, no one is happy.” Take care of your cash flow and that positive cash flow will take care of everything else.