Cash is king! Cash is king! Cash is king!
Individuals as well as businesses need cash in order to survive, grow and prosper. Without cash, both people and businesses would fail and cease to exist. And that is not what we all want.
Therefore, making sure that we have enough cash, and that businesses also have enough cash, becomes of the utmost importance.
What is Cash Flow?
Cash Flow shows movements of cash within a business.
Cash Flow relates to the timing of payments – receiving cash and spending cash. It is the sum of Cash Inflows, all the cash payments flowing into the business mainly from customers, less Cash Outflows, all the cash payments flowing out of the business mainly to employees, suppliers and lenders.
Business owners of unincorporated businesses and managers of limited companies need to manage Cash Flow well in order to prevent businesses from failing.
Why is managing cash important to a business?
The business needs to carefully manage all those Cash Inflows and Cash Outflows in a proper and timely manner, so the daily operations run smoothly and the firm is operating profitably.
The receipts received and payments done must be timed properly, so the business does not run out of cash when it is needed. Appropriate Cash Flow management allows the firm to have the correct amount of finance at the right time.
Business managers need to make sure that there is enough cash coming into the business from sales of products to customers to cover the amount of cash that is leaving the business being used for payments to employees, suppliers and so on.
Financial documents that help manage Cash Flow
- Cash Flow Statement. A financial document that shows the actual movements of cash in and out of a business, per time period usually one year.
- Cash Flow Forecast. A financial document that shows expected movements of cash in and out of a business, per time period usually one year.
The importance of Cash Flow to different stakeholders
Many surveys show that poor Cash Flow management is one of the main reasons why many new businesses fail despite making a profit. Business managers need to emphasize the importance of cash to their businesses, how it can be effectively managed in relation to various stakeholder groups and what businesses should do, if cash shortages emerge.
A. Internal Stakeholders
Internal stakeholders are members of the organization who have a direct interest in the decisions and activities of a business. Internal stakeholders include owners (shareholders), directors and managers, and employees.
1. Owners (shareholders)
Proper Cash Flow management is essential to all businesses’ survival and growth. It is not only necessary to own a business which is making a profit, but also the business which is managing cash in the right way. So, the business can keep running. Good financial control helps a business to better achieve its overall organizational aim and business objectives.
2. Directors and managers
Businesses will spend cash on paying salaries to directors and managers. These salaries need to be paid in full and on time. Many other financial rewards are also paid to the management such as performance-related pay, profit-related pay and fringe payments (perks or benefits) that all use some sort of monetary payments, meaning cash.
3. Employees
Businesses will spend cash on paying wages to the workers. These wages need to be paid in full and on time, otherwise poor motivation and absenteeism emerge which may increase labor turnover and even cause industrial unrest.
B. External Stakeholders
The same as internal stakeholders, external stakeholders also have an interest in the decisions and activities of a business. But, they do not form a part of the business. External stakeholders include customers, lenders such as banks or microfinance providers, suppliers, the government, local community, pressure groups and competitors.
1. Customers
Typically, the business receives payments in cash when it sells products (goods and services) to customers. However, in addition to cash, customers might be given several payment options when making a purchase, e.g. in cash, by cheque, by credit card, through trade credit, etc. When customers choose any of these payment options, they buy now but pay later. The firm does not receive the cash at the time of purchase, but at the later date, sometimes even as late as 30, 60 or 90 days. While offering a variety of payment options may attract more customers, it can also cause Cash Flow problems for the business, if cash is not managed properly.
2. Lenders
Lenders such as banks and microfinance providers often require a Cash Flow Forecast to help them assess the financial situation of the business that is seeking external finance. Lenders who provide external finance to the business need to be paid Interest on loans in a timely manner, and the capital needs to be repaid in full upon maturity date. If lenders are not paid on time, they will force the business into liquidation. A business is insolvent when it cannot meet its short-term debts. When a business is insolvent, the business will cease trading. And then, the business’s assets will be liquidated (sold out for cash) in order to pay the creditors. Cash Flow Forecast can help business managers to anticipate and identify periods of potential liquidity problems – when there is not enough cash. This will allow managers to predict and plan cash accordingly by increasing Cash Inflows and decreasing Cash Outflows, or seeking alternative sources of finance, e.g. overdraft, short-term bank loan, etc.
3. Suppliers
Businesses need sufficient cash to be able to pay its suppliers on time. Otherwise, suppliers will stop giving trade credit to the business, start demanding immediate cash payments or even stop supplying raw materials at all. Also, when utility bills are not paid as required, supplies of water, electricity and gas will be cut off.
4. Government
Businesses will spend cash on paying TAX bills owed to the government. In case of any fines that must be paid, firms will also use cash for that. Businesses may also receive grants and subsidies from national government and local governments which will be in the form of cash.
5. Local community
There are many cash-rich businesses in the economy. Some of them have accumulated cash holdings worth billions of USD$. There are a few things that businesses can do with the excess of cash. For example, buy back its own shares, take over or acquire another firm, pay off its debts or buy more stock. Business expansion of cash-rich firms will be especially beneficial for the local community. As local suppliers will see increased demand and the business will most certainly need more workers. That will create more job opportunities for the local community.
6. Pressure groups
The company may want to avoid any sensitive information regarding cash levels falling into the hands of pressure groups. This could cause pressure groups to take actions that can go against the interests of the business and its shareholders.
7. Competitors
The actions of rival firms may directly affect the business’s Cash Flow situation and lower market competitiveness. Aggressive marketing campaigns and price reductions by competitors may negatively influence the business’s sales causing Cash Inflows to deteriorate. Also, the appearance of a new competitor could both lead to reduced demand and poor Cash Inflows.
The importance of Cash Flow to start-ups
Cash Flow is certainly vital to new entrepreneurs and business start-ups.
Finance is very limited at new companies, planning is never accurate and suppliers give shorter trade credit periods. In addition, banks trust less, or do not trust at all, entrepreneurs who do not have proven trading record.
Clearly, the consequences of not having enough cash in a new business, or inappropriate Cash Flow management, can be very serious.
In conclusions, being a profitable business is very important in the long-term because it is the only way to run a business sustainably – expand and generate expected returns from investment for the business owners. So, profit becomes more important for the long-term success of the firm. However, cash is crucial in the short-term because it allows to pay the expenses necessary for running a business on daily basis. It is cash, not profit, that pays the day-to-day bills that need to be paid to keep functioning.
