In a recent Entrepreneur University post, YoungEntrepreneur.com blog reader Bob Foster asked about how to make important cash flow decisions.
Therefore for this edition of Entrepreneur University we turn to Madhavan T Gopalachary. Madhavan is an independent management consultant who has nearly 35 years in the corporate world.
Today Madhavan discusses the importance of cash flow management:
“Customer satisfaction, Employee satisfaction and Cash flow are the three most important indicators for a business – Jack Welch
Many enterprises try to take good care of customers and employees but often fail to take good care of cash flow. In some organizations, the receivables run into more than 90 days. As a rule of the thumb, any receivable above 120 days can be classified as a doubtful debt. This problem is more in the case of SMEs and organizations that compete on low prices. I have often found many sales people shy to ask for the payment after supplying the material or providing the service. I have even found some of them apologetic and afraid to ask for it, which is amazing.
If a company has positive cash flow, then there is no problem except to identify where to invest the excess cash surplus. You must ensure that the investment can be quickly encashed when necessary. In the case of negative cash flow, the problem is very serious. You can’t pay the bills and wages in time. You may not be able to borrow beyond a certain limit. One starts borrowing from Peter to pay Paul at higher interest rates. Soon the whole world comes to know about it. Ultimately, one goes broke. The major cause for bankruptcy is inadequate cash flow rather than a loss in operations.
However, negative cash flow doesn’t necessarily mean disaster or mismanagement. A rapidly expanding company will require large cash flows to finance new projects, R&D and other investments. Some companies have seasonal cash flow. In lean periods such companies may not have adequate cash flow. The main danger is when the short term borrowings or current liabilities become too high to be met by current assets. That is the current ratio will be below 1. Such companies are ‘Technically Insolvent’, even though they may be making profits on paper. Many good companies do prepare a projected cash flow statement and compare them with actual cash flow but it is largely said than done.
Please do not assume that SMEs only have cash flow problems, but it is no doubt, a major problem for them. However, the giant Lockheed Corporation was bailed out by US Government because it went overboard on its Tristar project and Mr. Lee Iacocca was given a loan by the US Government to save Chrysler more than 2 to 3 decades ago. Both became the biggest turnarounds in business history.
There is nothing esoteric about cash flow. It is very simple. You must have a regular and steady income. You must plan and budget your expenses and spend less than your income so that you will always have some reasonable surplus at the end of the day. Unfortunately, to quote Mr. Robert Heller ‘ Like good health, a positive cash flow is something you’re most aware of when you haven’t got it. That is one of the most profound truths in life.”
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