It never ceases to amaze me how many smart people don’t seem to understand this one topic. It’s basic MBA stuff, but even MBAs don’t get it. Perhaps this is symptomatic of an era of easy financing and business models that make no sense, but I run into this issue even when speaking with colleagues seeking advice as to how to get their businesses charged up.
Cash flow is king. If you learn nothing else during your adventures as a new venture owner, you must come to understand and appreciate just how important cash flow is to the health of your company. There are many ways in which cash flow can and will impact your company, and I would like to lay a few of them out for you.
A question I get often from entrepreneurs goes something like this: “I am growing my revenues like crazy, but I just never seem to have any cash. What is going on?” Cash flow my friend, cash flow. More specifically, as is usually the case with the folks that are asking these questions, operating cash flow. Of the three financial statements that I look at when I consider investing in a business, cash flow is where I spend a lot of time when I see problems with a business. As is often the case with a small business, managing the receivables and payables is critical to success. The revenues that come in the door are only helping you, cash wise, if you are collecting your receivable. If you aren’t, you have most probably already spent the cash to build your product for the customer. In fact, you are probably getting called right now by your vendor looking for their money.
Your operating cash flow is chiefly governed by your current assets and current liabilities. Any changes in these will impact your cash flow. For example, if you are building up your inventory, it’s going to cost you money. Sure, that inventory is available for sale, and it more or less represents money in the bank (in that you will – hopefully – sell it), but you still have to pay for it, and that uses cash.
As for your payables, one of the tactics that I tell my clients to explore is trying to take advantage of any early payment offers. 1% may not seem like a lot to you now, but when consider that on an annualized basis, that’s more than 12%, that’s not a bad use of capital. This is because you were probably going to have to pay within 30 days anyway, maybe 45 if you stretch your payables. By paying early, you are using cash, but you are also paying less. Think of this as a free loan from your vendor at a very favorable rate.
It is also important to understand that a dollar today is worth more than a dollar tomorrow. With that in mind, why would you allow the folks who owe you money to take their time paying you? You wouldn’t. Similarly, you would want to take as long as you can to pay your vendors, within reason of course. This has to do with the time value of money, and the notion that you can invest that dollar you owe today and collect interest on it. If you pay now, no interest. If you can get the pre-payment option, that’s great, but if not, think about making sure money takes as long as possible to leave your accounts.
Cash is king. Without it, you cannot operate. Growing like a weed is great, but if you aren’t collecting your cash, you are going to hit a wall. Knowing the number days it takes you, on average, to collect your receivables and pay your payables will give you a window into how your business is operating. These tersm are usually called receivable days or days sales outstanding, and days payable.
One last note. I bring this up only because I have seen this a few times and want to share. If your receivables are going up faster than your revenues, then your customers aren’t paying their bills. You see, if your revenues are flat, your receivables should be flat if you are collecting your cash from your customers. If not, your receivables will grow, which is taking cash flow out of your pocket, and putting you in a position where you cannot have sustained growth.