why-should-mid-and-small-sized-businesses-avoid-profit-trap-and-treat-“cash-flow”-as-king

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Why should mid-sized and small-sized businesses avoid profit tap and treat “Cash Flow” as king?

Most entrepreneurs always fail to understand the impact of Cash v/s Profit shown in the P&L. Unlike big businesses, small businesses face several challenges in operations, for example,

1. Customers do not respect the credit due dates

2. Speed of cash conversion rate

3. Vendor pressures

4. Retaining key performing employees

5. Small budget availability for business expansion and marketing

6. Nearly every option for credit, 

 The above-mentioned challenges squeeze the cash flow of the entrepreneur. For example, the first one,  “Customers don’t respect the credit due dates”. Most entrepreneurs cannot pressure their customers because most customers generally have several similar suppliers to choose from. If you have 30 days of credit on an invoice, the customer never pays it before 45 days, even after several calls/emails.

 Maximise the profitability,  Reduce Cash Risks,  Assess and forecast cash risks

Therefore, cash flow becomes “King”.   Since most of the P&Ls are prepared on an accrual basis, they do not reflect the real cash position of the company. The following few points are important for the very survival of any business. Especially small /medium businesses.,

1. Liquidity

Cash flow provides a clear view of a firm’s liquidity—its ability to meet its short-term financial needs. A positive cash flow indicates that the business is generating enough cash from its operations to be self-sufficient.

2. Survival

Every business needs cash to honour its bills, including salaries, rent, and vendor payments. The P&L might show a profit, but if the company's cash is blocked in outstanding invoices/ Accounts Receivable, it can't pay its immediate obligations. This is the single biggest reason for the failure of any business

3. Financial planning and Forecast

Small company owners often can’t afford FP&A Experts, who can manage financial planning, forecasts and budgeting of their business. Most of the time, they are so busy and immersed in their business issues like growth, sales, product development, and collections that they neglect financial management. They might overestimate their revenue and underestimate their expenses. Whenever even one single customer fails to pay on time, the business will be under pressure to pay its expenses.

4. Cash conversion cycle

It is always considered that the best business is one which has lower days outstanding on its cash. What it means is, if you are raising your invoices to customers today, you are receiving the payments on or before the due dates. If that happens, you are able to pay to your suppliers on time, they will be able to supply raw materials of quality on time, and you will be able to produce the finished products also on time. If at any one point, your cash is stuck. The entrepreneur has to arrange cash/ seek a working capital loan, etc.

5. Upfront costs to run the business

Specifically for manufacturing businesses, they have to produce the product, procure necessary inventory, pay several labour and other charges, where they spend most of their cash. However, they get paid by customers only after 30 or 60 days after the sale. This blocks a major portion of liquid cash available to businesses, making it difficult to deal.

 In this entire story, we can understand how cash and financial management are most important to run a business, rather than just focusing on accounting or preparation of P&L. The best way to manage these financial operations is to hire at least a fractional FP&A resource who can 

a) prepare a financial forecast,

b) manage cash,

c) alert to the late payments,

d) keep track of business finances

You can connect to Mr Guru Gokak - email: guru.oceanblue@gmail.com