Best Friend & Corporate Killer: ‘Cash-flow’
There are many text book examples of formulas and various CFO philosophic differences regarding cash flow that I could review, but the relational processes that cash flow has on business are where many entrepreneurs lose their way and need guidance.
It is a simple fact that all human beings need nutrition to survive. The nutrition ingested as food is rapidly consumed as fuel. If you impede this nutrition for a significant amount of time, you will starve to death. The rule is simple—consumption must be balanced with replenishment in order to maintain stasis. The same applies to your company. Businesses receive their nutrition from cash, without cash they cannot survive. The cash conversion cycle is the circulatory system for a business and the nutrient essential for survival is cash. Similar to the biological process, companies need to break down cash for consumption in order to distribute to the elements supporting their vitals. Accounts payable, accounts receivable, inventory, capital expenditures and growth are all as vital to a company’s survival as the heart and brain are to human existence.
Similar to the nutrients that fuel energy, businesses rapidly consume the cash that supports operations. At a minimum, periodic replenishment must match the pace of consumption to maintain stasis. If you significantly impede cash-flow over a long period of time, the vital processes will begin to fail resulting in starving your business to death.
Many business owners incorrectly believe that cash-flow equilibrium is the automatic outcome of profitability. Unfortunately, they think that as long as the company is profitable, the cash consumed will be less or equal to the cash inputted. The reality is, cash-flow management is a planned and directed process. You must analyze rates of consumption in rhythm with rates of infusion. Thoughtful consideration of all the variables that need to be configured to maximize cash-flow management requires action. Understanding the equilibrium increases your success. Respect the rule to ensure corporate survivability! Surprisingly, many businesses still choose inaction.
There are many factors that cause cash-flow starvation and very few exceptions to one inevitable truth; cash flow starvation is the grim reaper responsible for nearly all failed companies. Many otherwise highly skilled entrepreneurs make the fatal mistake of confusing profitability with cash-flow. An indicator of this behavior reveals itself when the business plan is primarily focused on sales and marketing—hazardously ignoring the redheaded stepchild. As cash starvation rears its ugly head, business owners quickly look to increase sales and feed a negative cash-flow crisis. The problem is that increasing sales usually increases operational costs and hastens consumption. With poor planning, even fixed costs become variable costs thus antagonizing the problem. Planning for growth requires both a heightened awareness of operations and cash-flow as a relational dynamic. Growing too fast without a forward plan has provided many businesses a crash course in ‘hitting the wall’.
During the winter months, food can be scarce or nonexistent, for many of the wild animals living in the northern regions. In order for bears to survive, they must fatten up before hibernation. Companies that have seasonality peaks and troughs, or cyclical intervals, in their markets should take a lesson from the bear if they wish to survive winter markets. Building cash stores while slowing consumption in a cyclical market requires planning. Variable costs are the easiest reductions to target. Strategic consideration of inventory-turns and break-even points also need to be weighed into the forward planning of seasonality cash-flow. Planning for depreciation has multiple positive impacts on cash-flow. There is an even greater ancillary benefit of expensing depreciation—it creates a shock absorber for the larger, inevitable consumable capital expenses.
Controlling cash flow is a planned event. If you want to go somewhere, you must first have to define ‘somewhere’. The next step is to plan your journey—business planning is the map you need to navigate this journey.