Cashflow: Dangerously Short?

When you are starting a business or are in the early stages of running a business, you might hear a plethora of business phrases and business jargon thrown around. Most business owners have a basic understanding of what it means to generate a “profit”, but they will often hear that they should be as much or more focused on “cash flow” as they are profitability. But what does “cash flow” mean, practically speaking?

Cash flow refers to the actual money (dollars and cents) coming into your business and going back out of the business, over a certain period of time. How does this concept differ from profit? There are often “non-cash” items that may be included on your profit & loss statement that don’t actually represent money coming into or going out of your business in that period. Let’s say, for example, you obtain a small business loan, and the loan proceeds distributed to your business amount to $95,000 in the month of December. If you were to run a profit & loss report for the month of December, your income would not include the $95,000 because this money is not business revenue; rather, it is a loan that your business is obligated to pay back over time. However, if you ran a statement of cash flows for the same time period, you would see a cash increase of $95,000. Cash flow is important because “on paper” or, more specifically, on a profit & loss report,

a business might seem like it is performing well when in actuality, it is critically low on actual cash needed to meet the immediate business needs.

These needs include expenses such as payroll, rent, supplies, etc. This is especially true for accrual basis businesses that recognize revenue when it is earned. For example, a business might have recognized $300,000 in revenue year-to-date because the business has completed the work and invoiced its customers, in the amount of $300,000. However, if the business’ customers delay payments for the work that’s been done, and the “accounts receivable” balance (money owed to the business) for that work is say, $250,000, this means the business has only received $50,000 of that revenue it has already recognized. While profitability might be high for the business year to date, in this situation, the cash position is poor, causing the business strain as it seeks to meet its payroll and other operating expense obligations.

One trend amongst business owners and their advisors is to be overly concerned with cash flow, to the detriment on the business’ long-term health. “Cheap money”, i.e. business loans with low-interest rates and favorable terms, is often appealing to business owners without a business reason for obtaining such funds. While it is possible to have successful profitability and a suffering cash position, it is also possible to be reporting sustained losses and have excess cash on hand. However, this scenario doesn’t play out well, unless the financing obtained starts to be put to “good use”, and the profits of the company are turned around.

As a business owner, especially one who wants to scale, it is critical to focus on both your net income and your cash position. Business owners face a myriad of decisions they must make each day, but a wise business owner will carve out time to review and analyze these numbers, as a part of their duty to the company and as a necessary step to scaling a healthy, thriving business.