The return to cash: Refocusing on the importance of cash flow

There’s an old business saying: ‘revenue is vanity, cash flow is sanity’. While high revenues from sales look great, they can mask potential pitfalls if businesses aren’t in tune with their cash flow.

Cash flow is of vital importance to the health of a business and not being on top of it with regular monitoring and reporting can fell even large businesses. Something Pie Face, Quicksilver, Homeart, Wendy’s and Australia’s oldest chocolatier, Ernest Hillier, can attest to. These are the headline failures but there’s a more pernicious trend with Australia’s small businesses that has the makings of an economic time bomb.

Almost 97% of all Australian businesses are SMEs and according to the Australian Bureau of Statistics, more than 60% of small businesses cease operating within their first three years. Further research from the Australian Securities and Investments Commission (ASIC) shows that half do not survive their fourth year. These are businesses that millions of Australians rely on for employment.

The threat of such a large number of businesses continuing to cease operating, and potentially not be replaced by new enterprise, should be of grave concern – especially when so many bankruptcies and insolvencies can be avoided with good cash flow management.

Case for reporting

In recent years, the cheap cost of credit has caused too many business owners to overlook their underlying cash flow performance, papering over the cracks with the traditional profit & loss and balance sheets. Many Australian businesses are not required to formally report cash flow, so this oversight is not unexpected.

Not all businesses that fail do so because of poor cash flow management, but nearly all businesses with bad cash flow fail. Business owners cited poor strategic management, inadequate cash flow, and poor record keeping as the primary causes for their failure. The message is clear: if poor management doesn’t get you then cash flow will. Constant cash flow vigilance is the solution.

Building cash flow into your monthly or quarterly management reporting packages will help you keep track of your cash during any given period. This information will allow you to anticipate and plan for those difficult times when outflow exceeds inflow. There’s nothing more stressful for a small business than being caught short on bills and supplier payments by a few days or weeks and getting hit with penalties on past due invoices at the time when money is tightest.

Cash flow cushion

For this reason it is recommended that businesses maintain a cash balance of at least two months’ worth of overheads to cope with any unexpected downturns in sales or delays in receivable invoices. Highly profitable companies go bust all the time because their capital is tied up in assets. During, and in the aftermath, of the 2008 financial crisis the companies that fared worst were those with little to no working capital and no bailouts to fall back on.

Customers pay late, suppliers apply penalties for late payments, equipment fails, sales slow and contracts get lost. These are unavoidable facts of business that can cause an existential crisis for an unprepared company. A cash flow cushion can help mitigate these risks and avoid disaster when it is most wont to strike.

With all the sophisticated data warehousing and reporting that is available these days there is no excuse for businesses not to be closely watching their cash. Those that do not are leaving themselves wide open. Cash flow is one of the most challenging elements of commerce but those businesses alert to inflow and outflow fluctuations, and reporting on their cash flow, are the ones best geared for future success.