7 Myths About Business Cash Flow
Posted on 28th June 2016 in Cash Flow
Written by Ross MacLeod
90% of small businesses in the UK fail every year due to cash flow. Here we dispel seven common myths about business cash flow
Setting up and running a business can be an exciting time, but it comes with its fair share of stress. 90% of small businesses in the UK that fail every year are taken down by cash flow problems, while in Australia, 40% fail due to inadequate cash flow or high cash use.
It goes without saying that getting the financials right from the beginning is a surefire way of giving yourself and your business a fighting chance of being part of that 10% success story.
Here we dispel seven common myths about business cash flow:
1. Cash flow is all about having cash in the bank
Wrong! While cash is indeed the oxygen that any business needs to live and breathe, most businesses aim to provide greater financial returns than the level of interest earned by simply placing the cash in a bank.
Reinvesting cash back into the business in the form of, for example, stock, staff, premises and/or equipment is the best (and some may say only) way to grow and develop the business. So while having cash in the bank is, of course, necessary, not to mention a good sign that you’re doing something right, it’s how you manage and spend the cash flowing back out that is just as important.
2. You can never have too much cash
Yes, you can actually. Cash itself does not earn anything, so holding too much cash could mean potential losses of earnings. Sometimes it’s better to invest in assets, and the best ones are those that allow you to release cash at short notice. Always be mindful of the liquidity position of your business though. The closer an asset is to cash, the more ‘liquid’ it is.
A deposit account at a bank or stock that can easily be sold are liquid. Assets such as buildings are the least liquid. Liquid assets are those that are most easily turned into cash, so choose your investments wisely – a long-term investment is no good if your business requires funds in the short term.
3. I can always bridge a gap in my cash flow with a bank loan
Not always. One of the key issues in cash flow management is ensuring that a business has the right kind of bank finance. The essential choice is between a bank overdraft and/or bank loan, as well as more recently, invoice financing (creating capital out of a business’ outstanding invoices) check out marketinvoice or Satago. Cash flow is a daily need for any business, but especially so when it is not easy to obtain credit.
Banks are the traditional ‘port of call’ for businesses with cash flow problems, however, the banking crisis and related economic downturn between 2007 – 2012 made many banks more nervous about lending to businesses.
Borrowing also becomes more expensive as interest rates are raised to partially offset the risk of borrowers not paying back loans. So while bank loans can be considered a helpful safety net, don’t rely on them to always be there unconditionally.
4. If my cash flow shows a negative balance, it’s game over
It doesn’t have to be. Many businesses may continue to trade in the short- to medium-term even if they are making a loss. This is possible if they can, for example, delay paying creditors and/or have enough money to pay variable costs. However, no business can survive long without enough cash to meet its immediate needs, and it’s for this reason that a cash flow forecast should be considered to be your lifeline.
Being prepared for all scenarios in advance of their occurring can give you a fighting chance of a) hopefully avoiding being in that position in the first place, and b) being able to do something about it early enough if it looks like you’re heading in that direction. That’s why scenario planning is so important: what are your best and worst cases? If you’re planning for it, you’re prepared for it.
5. If my income statement is healthy, my cash flow must be too
If only this were true! Closing the deal, making that sale, and delivering on your promise in order to win repeat business are all vital components to building a company, but just because you have invoiced for the services rendered doesn’t mean you can count your chickens before they’ve hatched. If you don’t receive payment when it’s due, your business could fall into trouble fast.
It only takes two or three late payments before small businesses can find themselves with a cash flow problem, and you begin to fall behind on your own financial obligations. So the key is keeping a beady eye on the amount of cash actually flowing into your bank account, rather than what you expect to receive. If it’s not in the bank, don’t count it!
6. The health of my cash flow has no impact on my day-to-day business activities
Not the case. Better cash flow gives increased bargaining power with suppliers and less need to concede discounts to customers. A vulnerable business owner battling negative cash flow is more likely to make rash decisions that they may later regret; desperate times call for desperate measures.
Being able to walk away from a bad deal or maintain your RRP not only keeps the company afloat, but it preserves and nurtures a brand’s reputation too. Providing discounts to valued, loyal customers is one thing, but being forced to sell at cost just to get a cash injection is not a long-term plan.
7. Looking after cash flow is my accountant’s responsibility, not mine
A good business owner always takes accountability for all aspects of their business. While an accountant can guide, support and advise, it is not their 100% responsibility to keep a track of your business cash flow, and even if they do so out of the kindness of their hearts, they certainly won’t be monitoring it as regularly or closely as a business owner should be.
Apart from it being sound business practice, staying on top of cash flow management and removing any cash flow worries allows more time to be spent developing and improving the business.