King Cash, Queen Cash Flow and Prince Profit
You need cash to run a business. Cash allows you to pay bills, cover payroll and make capital improvements to drive expansion. However, cash runs out quickly and must be replenished through a steady cash flow for the business 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 preparing to wash your face provides a simple analogy for these complicated and intertwined financial metrics. Both tap and drain represent a cash flow that can be further defined as inlet (tap) and outlet (drain). The water that is poured into the sink is analogous to the income that comes into the company. For cash inflow, it doesn’t matter if the product / service was sold at a profit or loss, just that the revenue flows. Rather, all of the company’s expenses, from the electric bill to insurance, payroll and supplier charges, are represented by the drain. Just like water comes out of the sink, cash comes out of the business. The water that collects in the sink represents available cash. Finally, increases (gains) or decreases (losses) in the amount of water in the sink, from one measurable time to another, represent the profit of the company.
So, for example, a business can measure profitability monthly, quarterly, and / or annually, which means it is comparing revenue inflows minus expense outflows to determine which was higher during the period. If the receipts were higher, the company was profitable. If the outflows were higher, the company was operating at a loss.
Every measure of financial achievement is necessary. What’s more, increasing each measure is essential for continued growth and operations.
King Cash rules the kingdom. The greater the amount of cash in your business, the better you will be able to sleep at night. Although savings do not solve problems, they do give you something unattainable in another way: time. If the business is trading in the red (unprofitable) or cash outflows are greater than inflows (negative cash flow), the cash on hand gives you the time you desperately need to correct these problems. Both will need to be corrected to survive; cash gives you time to figure out how to turn things around. Ironically, by definition, the cash your business has now comes from positive cash flows and profitability at some earlier point in business history. It was carefully collected each year on the retained earnings line on your balance sheet and stored in your savings account.
In the absence of available cash, the business must go into debt in tough times. Unfortunately, banks and lenders are slow to lend cash to troubled businesses. So, if your business is in trouble and you didn’t execute a financial disaster preparedness plan when times were better; there is little you can do other than liquidate assets. If, on the other hand, all three metrics are on the rise, now is the time to request or increase the company’s line of credit. This is best done with a large, recently signed contract in hand and the latest financial statements carefully printed and expertly bound.
Queen Cash Flow:
King Cash rules the kingdom as its head of state; But, Queen Cash Flow is her neck. And everyone knows that the neck turns its head. So, assuming your business is not cash rich, the metric that rises above the rest in demand for your attention is cash flow.
Imagine a situation where the business is profitable on paper, which means 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 income must be entered as Accounts Receivable; however, it has not reached the firm’s door. How long can a company survive? Assuming that the company has no cash on hand and no means to acquire a quick and 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 company after a payment date has come and gone without payment? Suffice it to say that the disappearance of the company is measured in weeks, not months or years.
Businesses are in business for profit – period. Without profit, there is no growth, and corporate value declines as assets age and depreciate. Winnings, like the Crown Prince, must be treated with respect to prepare for the future. Winnings can 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 company is in jeopardy.
Financial metrics are the royalty of the company. Each must be cared for and cultivated. As cash flows increase, available cash 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 when you were little: “If Mom isn’t happy, no one is happy.” Take care of your cash flow and that positive cash flow will take care of everything else.