The Importance of Cash Flow
Running a business seems pretty straight forward until you really get cranking along. Then suddenly, the issue of cash on hand becomes a big one. This points out the importance of cash flow.
What is cash flow? It refers to the money you have on hand at this very point in time as well as projections of money coming in. Why is cash flow important? It is a vital issue that you have to grasp and plan for if you want your business to be a success. It is as simple as that. Let’s take a closer look.
Most business owners focus on profitability as the biggest issue with their building. Indeed, it is vital in the long run, but focusing solely on it can lead to problems down the line. How so? Well, you can have a lot of potential revenue coming in, but it doesn’t mean much when you have to pay bills today. Here’s a common situation that happens.
I own a small factory making a new type of battery for hybrid cars. I do okay, but not great while everyone drives SUVs. Suddenly, gas prices go to $4 a galloon. Hybrid sales go nuts. Toyota and Honda order 5 million of my batteries net 60. Everything is coming up roses for me, right? Umm, maybe not.
What is my problem? It is simple. I don’t have enough cash on hand to buy the materials I need to put together 5 million batteries. On top of this, I certainly don’t have the money to pay my labor to do the job. I am going to make huge profits if I can get the job done, but my cash flow is such that I am probably not going to be able to fill the orders. This points out the importance of cash flow. Sometime, money on hand is more important than profits.
So, is there any way to get around this problem? Well, one is to go to your local bank and see if they will give you a loan. Sometimes they will, sometimes they won’t. The problem is the decision making process takes so long that the final answer is almost irrelevant. A more timely option is to seek out a factoring solution.
Toyota and Honda are highly likely to pay their invoices. With this in mind, any factoring company would by your invoices for these companies and probably charge you one or two percent of the total invoice. The real value of such a relationship is the factoring company will pay you the money within two to three days.
The importance of cash flow cannot be understated. Every business needs to know if they can meet their obligations now, next week and beyond. Make sure you understand it thoroughly and methods for planning for cash flow problems.