Cash Flow: The Oxygen of Business
We’ve all seen enough movies to know how to conserve oxygen if we’re stuck in a lift. Don’t speak too much, don’t shout and definitely don’t light a fire! However, there are many Australian businesses who soon find it hard to breathe because they are doing precisely all of those things.
Often it is done completely unwittingly. Not being in tune with cash flow is akin to lighting a fire in a confined space with no idea when or if fresh air will be coming in. Whilst high sales figures look great they can often paper over some serious cracks.
What are seemingly minor cosmetic issues can quickly become major structural problems that 3 in 5 small businesses cannot overcome. Almost 97 percent of all Australian businesses are SMEs and according to the Australian Bureau of Statistics, more than 60 percent of small businesses cease operating within their first three years. Further research from the Australian Securities and Investments Commission (ASIC) shows that half do not survive their fourth year.
Cash flow is vitally important to all businesses and there are plenty of large businesses that have fallen foul because they’ve failed to monitor and report theirs adequately. Pie Face, Quicksilver, Homeart, Wendy’s and Australia’s oldest chocolatier, Ernest Hillier are just a few of the headline failures that should serve as warning and lesson to business of all sizes that bankruptcy and insolvency can often be avoided with good cash flow management.
Not all businesses fail because of poor cash flow management but nearly all businesses with bad cash flow fail. Surveyed business owners cited poor strategic management, inadequate cash flow, and poor record keeping as the primary causes for their failure. The message is clear: if poor management doesn’t get you then cash flow will.
Cheap credit in recent years hasn’t helped business owners maintain constant cash flow vigilance with many overlooking their underlying cash flow performance in favour of traditional profit & loss and balance sheets. To an extent this is expected as many Australian businesses are not required to formally report cash flow, however what businesses should do and what they are required to do should not be conflated.
It is up to business to go beyond the minimum effort in the mundane administrative tasks that are often undervalued until it is too late. Business can protect itself by building cash flow into their monthly or quarterly management reporting packages to keep track of cash during any given period. This information is critical in anticipating and planning for those difficult times when outflow exceeds inflow. Getting caught short on bills and supplier payments is stressful enough but Murphy’s Law says that is precisely the time when customers will miss payments or cancel orders.
Keep a Cushion
For this reason it is recommended that businesses maintain a cushion of at least two months’ overheads to cope with any unexpected changes in predictions. Highly profitable companies go bust too because their capital is tied up in assets. This was never more apparent than during the 2008 financial crisis where the companies that fared worst were those with little to no working capital.
Some businesses hubristically think their customers will never pay late, suppliers will never let them down; that they’ll never have to pay late so won’t ever get penalised, their equipment is so well-maintained it will never fail, sales will never slow and human error will never cost them a contract. These are the companies least prepared for the worst and according to Murphy’s Law the ones most likely to have havoc wreaked upon them. The best prepared survive the longest and have a cash flow cushion.
With all the sophisticated data warehousing and reporting that is available these days there is no excuse for business not to be closely watching their cash. Those that do not are leaving themselves wide open.
There’s an old business saying ‘revenue is vanity, cash flow is sanity’. Cash flow is one of the most challenging elements of commerce but those businesses alert to inflow and outflow fluctuations and reporting on their cash flow are the ones best geared for future success.