Cash flow, as they say, is king. We tell entrepreneurs this truism all the time. So why is it so true? Here are my top Six reasons for focusing on strong cash flow:
1. Strong cash flow can smooth out the effects short-term fluctuations in cash outflows. One of the most stressful aspects of cash flow management is the weekly cash flow crisis that so many entrepreneurs face. By enhancing inflows of cash, a short-term buffer can be created that can eliminate many of these crises.
2. Strong cash flow can create a rainy day fund. Every business will face a time when they face a more significant cash flow issue. For example, a major customer may stop doing business with you or may cut back their ordering. Or, this major customer may for some reason slow down their payments. I usually recommend at least a thirty day cushion for such events. That is, build up cash reserves (or highly liquid short term investments that can be converted quickly) equal to about thirty days worth of normal expenses. Businesses that followed this practice found that they weathered the economic backlash of 9-11. I have also seen this help for other unforeseen events such as hurricanes, floods, etc., etc. While we can never plan for such events, we sure can prepare for events like this. In one twelve month period our business had a hurricane (talk about rainy days!!) and an ice storm that both effectively shut us down for over a week!
3. Strong cash flow can create a war chest. Investments in new equipment or facilities, acquisitions of smaller competitors, or buying out a partner or investor can become easier with a strong cash position. Build an additional cash reserve beyond the thirty day rainy day fund for financing your own business.
4. Strong cash makes talking to bankers easy. Bankers love cash flow…enough said!
5. Strong cash flow makes periods of rapid growth less perilous. One of the most dangerous periods for any business is times of rapid growth. And one of causes of failure during growth is poorly managed or inadequate cash flow. Building strong cash flow going into periods of rapid growth can make these times much less dangerous for the business’ survival.
6. Strong cash flow creates value in the business. When it comes down to it, cash flow is what is used to value most businesses. EBITDA, which is basically a measure of cash profits, is still the basis of most business valuations. The better the EBITDA, the more value your business has in the market when the time comes to exit.