There are certain business fundamentals that have remained unchanged for centuries. One such principle is cash flow. Businesses of all sizes and types experience some amount of cash flowing in and out of the company. How that cash is managed is one of the most critical aspects in determining whether a company succeeds or fails.
Any entrepreneur looking to start a new business absolutely must understand the principle of cash flow and have a handle on cash flow management even before the idea of financing is ever entertained. Why? Because business lenders are all concerned about cash flow. All business loan offers will be tied to your cash flow. The same is true for equity investing, crowd funding, and so forth.
Here are five things every entrepreneur should know about cash flow:
1. The Difference Between Cash and Real Cash
The term ‘cash’ has two meanings in the business world. In general, cash refers to company assets and liabilities that are, for all intents and purposes, liquid. Assets would include money in the bank as well as outstanding invoices representing cash that will eventually be paid. Liabilities include outstanding invoices the company has yet to pay.
The term ‘real cash’ applies to the bills and coins coming in and going out. A restaurant is an example of an all-cash business that deals in real cash. They accept currency, debit cards, and credit cards all representing cash payments. In turn, they pay their suppliers and workers in cash represented by checks and electronic bank transfers.
The difference between these two terms is important when managing cash flow. Cash flow management relies almost exclusively on real cash for the simple reason that outstanding invoices don’t really have any value when you need money to pay a bill.
2. The Difference Between Cash and Profit
Next is the difference between cash and profit. Cash is a tangible asset you can hold in your hand. It is an asset that can be accounted for on a bank statement. Profit is not an asset. Profit is a measure of accounting. Why does this matter in terms of cash flow? Because it’s entirely possible to turn a profit and still not have any cash.
Accounting principles may demonstrate that a company is turning a profit. But that profit is only based on total revenues versus total expenses. It doesn’t account for outstanding receivables. A company might be turning a profit on paper and still be short on cash due to excessive receivables.
3. Cash Flow is Indicative of Strength
Next, cash flow is indicative of a company’s strength. This is because cash represents a company’s ability to sustain operations. Remember that cash is ultimately the only thing that pays bills. So if cash is constantly limited, a company is in a more precarious position.
You might be interested to know that buyers give quite a bit of weight to cash flow when considering whether or not to acquire a new business. Smart buyers know that consistently limited cash flow is a sign of internal weakness.
4. Cash Flow Affects Borrowing
The fourth thing entrepreneurs should know about cash flow is that it affects borrowing. You previously read about how business loans are often tied to cash flow. They have to be. A lender takes a certain amount of risk by loaning money to a business. If the business consistently deals with insufficient cash flow, a lender has to question that company’s ability to pay back what is borrowed.
In the end, the fact that cash flow is indicative of company strength means that it also affects a company’s ability to borrow. And because borrowing is a normal part of doing business in the modern era, it’s critical that companies manage their cash flow with borrowing in mind.
5. Budget Priorities Are Affected by It
Finally, entrepreneurs need to understand that budget priorities are affected by cash flow. The best way to illustrate this is to talk about payroll. Where a vendor is likely to allow up to 30 days to pay an invoice, workers don’t extend that same courtesy. They don’t allow employers to operate on credit.
The need to pay workers on time demands there be enough cash in company accounts to make payroll on time. That means other items in the budget might either have to wait or be addressed through credit. An entrepreneur cannot spend all his/her cash and then expect workers to wait to get paid.
As you can see, cash flow is a fundamental business concept on which sustained success rests. If you are going to start a business of your own, make sure you have a handle on cash flow first.