Why Cash Flow Is More Important than Profits
By Andrew Patricio
August 28, 2017
Small Business & Entrepreneurship
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Cash is king in every business. And that doesn’t just translate to profits. Profitable businesses shut their doors all the time because they don’t have the liquidity they need to continue operating. This can easily happen when you’re growing fast and spending a lot to finance that growth.
For example, say you just got a PO for finished goods worth $50,000. Congrats! You quickly ramp up production, spending $15,000 on raw materials and $7,500 in additional help to finish the order on time. That’s a total investment of $22,500, or, a $27,500 profit. Pretty good, right?
Not necessarily.
You’re not getting that $50,000 until you’ve delivered the finished goods, maybe 90 days or more after your initial investment. At the earliest. So you’re essentially out $22,500 until then while still having to pay rent, utilities, other employees and expenses in cash. This situation is OK when it’s sporadic but you can see how it can quickly become desperate for a small business. In the not-so-long run, this type of mismanagement will result in your inability to pay for the things that keep your doors open. It’s a very real threat and one every business, large and small works on.
So, how can you improve your cash flow? Talk to your accountant, of course, but here are some ideas to get you started.
Profitability is absolutely essential to your business, but you can’t continue operating without a healthy cash flow. Make sure you monitor both measures of financial stability so you can continue growing with confidence.
For example, say you just got a PO for finished goods worth $50,000. Congrats! You quickly ramp up production, spending $15,000 on raw materials and $7,500 in additional help to finish the order on time. That’s a total investment of $22,500, or, a $27,500 profit. Pretty good, right?
Not necessarily.
You’re not getting that $50,000 until you’ve delivered the finished goods, maybe 90 days or more after your initial investment. At the earliest. So you’re essentially out $22,500 until then while still having to pay rent, utilities, other employees and expenses in cash. This situation is OK when it’s sporadic but you can see how it can quickly become desperate for a small business. In the not-so-long run, this type of mismanagement will result in your inability to pay for the things that keep your doors open. It’s a very real threat and one every business, large and small works on.
So, how can you improve your cash flow? Talk to your accountant, of course, but here are some ideas to get you started.
- Keep cash in the bank. Cash will free you up to take advantage of new opportunities and absorb shocks to your cash flow. Most accountants recommend having enough to cover at least one month’s worth of operating expenses but it varies based on your business.
- Get paid sooner. No one said you have to set your terms at Net 30. You can set them at the rate that works for your business.
- Get a line of credit. You’ll have to pay interest, but it’s better to have access to liquid cash than stop operating.
- Require a down payment. This isn’t always possible when you’re filling an order with a new customer or a big company but it’s worth negotiating when you can.
- Offer an early payment discount. Set a tiered structure like a 15% discount for paying upon receipt, 10% for net 10 days and 5% for net 20 days.
Profitability is absolutely essential to your business, but you can’t continue operating without a healthy cash flow. Make sure you monitor both measures of financial stability so you can continue growing with confidence.