Everyone in business has heard the phrase ‘Cash is King’, in this blog we are going to explore why cash and cashflow is so important to any business.
The phrase ‘Cash is King’ highlights the importance of cashflow over profit and turnover. You can increase sales, and have profit, but if your business runs out of cash you could be in trouble.
When we talk about cash, we don’t mean just physical bank notes, but rather a combination of the money readily available to a company such as the current and savings bank balance, and any physical cash held.
What is cashflow?
Cashflow is the money flowing in and out of your business. Having positive cashflow means more money is coming in than going out. Negative cashflow means more money is going out than coming in.
How is cash generated?
Profits – The profits generated by a business usually convert to cash at some point. Many factors can affect when profit actually turns to cash, such as when your customers pay and when you pay your suppliers, but profit is what generates cash. If you aren’t making a profit then at some point you will run out of cash.
Customers Paying – The main source of cash going into your company is going to be from your customers paying you. If you are having cashflow problems this is the easiest place to identify problems. If your payment terms are 30 days, but your average customer pays in 45 days then you will have a cashflow problem. If your payment terms are 30 days and customers achieve this, but your suppliers terms are 15 days then you may have a cashflow problem as you have to fund that gap.
Bank loans – Loans are usually taken out to purchase equipment or premises, but they can be taken out to fund short term cashflow problems. Great consideration needs to be taken if looking to fund cashflow problems with a bank loan, as the loan will be repaid and interest will be payable so over time this will take more cash out of the business.
Investors – Start up companies may take on outside investment, this can help with cashflow as the business starts up and needs to spend money on equipment, staffing and advertising. Investors will expect a return in the future, and that will usually be a higher return than the interest on a bank loan due to the risk they are taking.
Why is cash important?
Funding Capital Costs – Most businesses need to spend money on capital expenditure such as computer equipment, vehicles and plant and machinery. Even if taking out finance most of these items will require a deposit. If cashflow is poor you may not be able to afford to invest in the equipment you need to generate profits in the future.
Funding Future Projects – Certain businesses may need to fund projects they start for customers. For example, in construction, materials may need to be purchased before the project starts or any money is received from the customer. If you don’t forecast your cashflow, you may not be able to start projects you are contracted to.
Funding Stock/Inventory – If your business sells products then it is likely you will keep a stock of these products. Items you have in stock is effectively money sitting on the shelves and not in your bank account. Depending on your profit and how much stock you keep this can be draining on cashflow. It isn’t always avoidable, you need stock to make sure you can sell to customers and not keep them waiting, so it is important to plan cashflow and stock purchases. If you make £100,000 profit, but keep stock of £85,000 you would struggle to pay the tax liabilities as your cash is tied up in stock.
Funding Expansion – As your business grows you will need to invest in new staff, they will need equipment to do their job and you may have recruitment costs. You may also want to advertise to gain new customers. These costs don’t always see cash generated from profit straight away. Your new staff may take time to settle in, or may not be utilised in full to begin with. It is important when expanding to consider your cashflow, and how taking on new staff may affect this.
Gives You Options – Having cash gives you options. If looking to purchase new equipment you may be able to put a bigger deposit down, lowering the interest rate and saving you money. It will also allow to ride market fluctuations and recessions if you have cash. You can also be more selective over who you work with.
There are options for funding the scenarios above, having cash can involve taking out a loan or taking on an investor into the business, not all cash comes from generating profits.
7 reasons businesses have no cash
Your business may be generating profit, but there are many other reasons why cashflow may be low or negative.
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Spending money on capital expenditure that isn’t being financed
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The business is making a loss
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Customers are not paying, or paying slowly
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Suppliers are being paid quicker than customers are paying you
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Cash is tied up in large stock/inventory balances
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Rapid expansion, investing in new staff and equipment that may not pay back instantly
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Owners are drawing more than the business makes in profit
On point 7, this often happens when business owners look at the cash in the bank, rather than the profits being generated to take their drawings and dividends. There may be cash in the bank, but have you considered the future tax liabilities and other obligations before drawing money out of the business.
Why you should forecast?
In order to make informed decisions about how, where and the timing of spending, it’s important to forecast if the cash will be available, if the business needs to finance the spending, and also to forecast the expected result of the spending.
Forecasting helps with loan applications and potential investors. Having a forecast will give the loan application a higher chance of success, as you can show the bank how you will spend the money, and how that will benefit the business and ensure the bank gets repaid.
If your business is growing you made need to invest in new people, equipment and machinery, and the payoff of that may not be instant. Having a forecast can show you what you can afford and when you expect that investment to pay back.
Every business should forecast 12 months ahead. You can see where times may be tight and adapt accordingly. You can track the business performance against the forecast and learn why it is different. As you get into the habit of annual forecasts you will learn more about your business and the forecasts will become more accurate.
How we can help?
We can help you:
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Understand where your cash is going
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Obtain finance
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Produce a three way forecast (profit and loss, balance sheet, cashflow)
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Track performance
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Track performance and compare to the forecast
If you need any help with cashflow, financing or putting together a forecast please contact us on 01245 801611 or contact us here.
