Why is Cash Flow Important?
Since cash is the lifeblood of any business, cash flow management is important to most businesses, and it is not to be confused with profitability. In fact, you could be profitable, while your cash is eroding. Conversely, you could be generating cash, but not profitable.
Related Post: Cash Flow Management: Mistakes That You Must Avoid
Rule #1: Growth Sucks Cash
Growing companies can experience more and more money tied up in accounts receivable, work in process, raw materials, and finished goods inventory. Therefore, growth companies need to be careful to grow only as fast as they can maintain a healthy cash position.
For more information on how fast you can grow read the 2001 Harvard Business Review article, “How Fast Can Your Company Afford to Grow?” by Neil C. Churchill and John Mullins.
Rule #2: You Can Grow Out of Business
The owner of a $10M per year flooring and window covering company recently contacted me again – as they have periodically over the years – because he's getting ready to transfer the business to a successor CEO. While growth is important to him, he has witnessed too many of his competitors scale so fast they go out of business. A business may have positive cash flows and be generating losses. If banks, suppliers, or venture capitalists are keeping these companies awash in cash, it doesn't mean they will survive at a fast rate of growth.
Rule #3: Growing at 15-25% Per Year is a Healthy Growth Rate
In my experience, a healthy growth rate that is sustainable for most companies will be between 15 and 25% annually. Rates higher than that may overwhelm the leadership team unable to keep up with such rapid development.
Rule #4: Focus on Your Solvency and Credit Worthiness
Positive cash flows please banks and financial institutions. A positive cash flow means the business enjoys steady and predictable cash flows which is what lenders appreciate and look for in their borrowers.
Rule #5: Cash Flow Management Enables Capital Spending
If your inflow of cash exceeds your outflow, then capital investment in property, plant, and equipment is more possible. Setting aside money in a controlled manner makes sense if you want to grow.
Finally, good cash flow management is required to make regular disbursements, e.g., salaries and other overhead expenditures, which keeps employee morale high and reduces stress-related to juggling finances. And better management and control over your cash reduces the likelihood of employee embezzlement.
I was honored to be featured in an expert roundup with other entrepreneurs by Porch this month, where we discussed funding your business. Read my excerpt here.