Why Cash Flow is More Important Than Profit

I was recently asked, “Why the emphasis on cash flow?” I gave the example of real estate and how highly leveraged businesses can look profitable, but still go out of business. My friend pressed on saying that he gets it in that context, but in all business?

The answer is yes. You can have poor profits, but if your cash flow is good, you’ll be ok. Of course you have to consider how the cash flow is good with poor profits, but if someone is willing to pour $30,000 a week into their business, and assuming cash requirements are only $10,000 per week, the business will continue as a going concern.

When it comes to cash flow there are three levers you can pull

• A/R (Accounts Receivable) turnover
• Inventory Turnover
• A/P (Accounts Payable) Turnover.

A/R Turnover

You can get more aggressive about collections. You run the risk of upsetting relationships with your customers. Another way, as Mike Milan points out in his recent interview on The Authentic Accountant Podcast is to improve your relationships with your customers?

How can you speed up collections while also improving relationships with your customers? Talk to them. Get them to see you as a priority. Get them to value you. Mike, in a former business called a customer and asked them to view him as a paycheck instead of as a paper towel vendor. A good sense of humor also goes a long way here. That’s how you do it without seeming like you are desperate (even if you are).

Inventory Turnover

You can improve cash flow by improving inventory turnover. Easier said than done, I know, but it can be done. Closer product analysis – what is selling. One strategy a client of mine taught me, as they were asking me about how to create the reports they needed was brilliant.

The had me show them how to run a report that showed their top selling items. Then we ran a report that showed the sales detail by item report, with the customers in there.

This enabled us to see which customers were not buying the top selling items.

Guess what we did next?

You bet. We emailed and called those customers to let them know about these top selling items that they were not buying. Nothing like a little FOMO (Fear Of Missing Out) to bump up sales.

There are many examples of how you can pull that inventory turnover lever to improve cash flow.

For a service based business, your labor force is your inventory (in a manner of speaking). In other words, you tie your cash up with them while they produce / provide the service, and that turns over into revenue with (hopefully) a profit.

Here you have to think of ways to improve the efficiency of the labor force without burning them out. So no, getting them to work more hours isn’t the answer. The answer is likely in finding ways to help them get their job done faster and more efficiently without putting in all kinds of hours.

• Better processes.
• Better software.
• Better training.

The trick is to get the staff running efficiently so you can take on more work without taking on more payroll cost. It’s not as hard as you think. A more efficient process might mean investing money in better software or better training on the software, but that cost is likely much more than balanced with the amount of additional revenues that can be brought in without having to hire more people either to replace the ones you burnt out, or simply to take on the additional workload.

A/P Turnover

This is a lever you can pull at the risk of upsetting your vendors. Have you ever worked with a company (usually larger ones) who told you they pay on (eg) 60 day terms? This is an example of a company pulling their A/P lever to improve cash flow. Bigger companies can get away with this because you need them more than they need you.They don’t care about your cash flow. They care about their own.

Remember that when you pull your A/P lever, you are doing so at the expense of someone else’s A/R lever.

Cash Flow is critical for every business no matter what the industry. Of course the cash flows have to come from operations ultimately, or the business will go under, but that’s only because cash flows from other activities will eventually dry up if they don’t somehow turn into cash flows from operations.

50,000 businesses file bankruptcy every year. That doesn’t take into consideration the businesses that just go under without filing. In every case it’s because cash flows weren’t sufficient to keep up with the obligations of the business.

That’s why cash flow!