The Importance of Keeping an Eye on the Cashflow
America’s small businesses are a vital component of the nation’s economic growth. Their wellbeing and longevity essentially depend on a healthy cashflow.
American small businesses that mushroom across the nation, year in, year out, are not just making dreams a reality for individuals, they are a vibrant engine of economic growth for the nation. Former U.S. President Ronald Reagan, once said, “Entrepreneurs and their small enterprises are responsible for almost all the economic growth in the United States.”
The Small Business Administration (SBA) records 30.7 million small businesses currently in the U.S., employing over 58.9 million Americans, which is almost half of the entire private-sector workforce. SBA defines a “small business” as an organization with less than 500 employees. Many startups in the U.S., therefore, can be considered small businesses.
Importantly, they have adapted to the needs of the times, engaging in digital marketing and advertising, especially learning how to use AdWords for Lead Generation.
This ability to change with the times is a boon to small businesses during the current COVID crisis, with 76% of them relying more on digital tools now than during pre-COVID times. Almost a third of businesses that participated in a recent survey said that they would have closed some or all of their business during the pandemic, had they not learnt to engage with customers digitally.
Nevertheless, even during normal times, not all small businesses are able to survive in a competitive business climate. Research indicates that about two-thirds of U.S. small businesses survive for two years, while 50% of all small businesses last for five years. Only 33% are able to go on for 10 years or more.
A recent U.S. Bank study discovered that 82% of small businesses fail because of poor cashflow management. Business experts advise that a good cash flow is one of the most important characteristics of a healthy business, and cash flow problems are a major cause of businesses failing.
As veteran entrepreneur and business plan expert, Tim Berry, says, one critical mistake businesses make, is equating profits to cash. He says, “You can make profits without making any money.” Profit is the money a company is left with once all expenses have been paid, and it is an accounting concept. Profits will not help pay bills.
However, the profit margin is a telling indicator of how much money a business makes from the money it earns. If a business has a low profit margin, it is because costs are too high, or the price is too low, or both. A company can expect consistent cash flow problems, if its profit margin is thin. In the long run, this spells trouble. Therefore, a business with thin profit margins should track it over time to get an idea of pricing and costs, and consider changing the dynamics to improve cashflow. A cash flow forecast could be a valuable tool to help make important decisions.
Therefore, from the launch of a startup business, it has to be vigilant of cashflow issues, and also should not underestimate startup costs.
Furthermore, just because a company opens its doors, it should not look for immediate profitability. A survey by Kabbage, an organization supporting small businesses, found that 84% of small businesses reach profitability within the first four years of operation. Only around 68% of businesses become profitable within their first year of operation.
Businesses, at some point, also realize that long-held beliefs are on a collision course with reality.
The dream of any business is to achieve growth. But growth brings problems too because it sucks cash from the company. So, more growth leads to a higher need for financing. For instance, if a business lands a large contract and finds it has to hire more staff, it needs to plan for a line of credit from a bank to pay the extra salaries it did not budget for, because the new client has not yet made payments.
Apart from growth, a company’s inventory also sucks cash, because a business has to build or buy its product, before it can sell. And even if the product bought or produced, lies unsold on the company’s shelf, the suppliers of the product expect to be, and have to be, paid. Tim Berry’s simple rule of thumb, is, “Every dollar you have in inventory is a dollar you don't have in cash.”
And, a successful business will always have sufficient cash available, to pay bills, loans, taxes and to buy new assets
Generally, if a company makes a sale, that is seen as money coming into the company. However, if one business sells to another business, the situation becomes complicated, even if the deal appears to be worthwhile. The selling company will deliver its product to the customer company, along with an invoice. However, if the sale is to a distributor who sells to a retailer, it will take at least four or five months for the original company to get paid.
However, if a business has cashflow problems, getting paid fast is critical. Money owed by customers to a company, is its “accounts receivable,” and, every dollar recorded in accounts receivable, is a dollar less in cash held by the company. Therefore, businesses need to be proactive in collecting receivables, and should only provide credit to customers who pay their bills on time. Also, there are online apps today that can help with sending invoices easily, and arranging for payment online as well. Overdue notices can be automatically sent digitally, to trigger prompt payment.
Experienced entrepreneurs understand that their biggest survival skill is their “working capital,” which is the amount left when current liabilities are deducted from current expenses. In practical terms, this is money the company has in the bank to pay bills and buy inventory until it gets paid by its customers.
As Secretary of the Treasury of Great Britain of a bygone era, William Lowndes, once said, “Watch the pennies and the dollars will take care of themselves.”