Cash flow is of significant importance to the health of any business. There is a saying: “revenue is vanity, cash flow is sanity, but cash is king.” Cash is the lifeblood on an organization, and while it may seem impressive to have significant inflows of revenue from sales, the most important focus for a business is the strength of its cash flow.
Cash comes into a business (cash inflows), mostly through the sales of products or services, loans and investments, and flows out (cash outflows) to pay for the cost of products or services, operating expenses, distributions/dividends, debt payments, and capital asset purchases. The end result is either positive or negative cash flow. It is important to note that just because a company is profitable, this does not mean that it has a positive cash position. Many businesses may continue to operate in the short to medium term even if they are operating in a negative cash flow position. They are able to operate by delaying the payment of creditors, however, no business can survive over the long-term without enough cash to meet its ongoing needs.
The statement of cash flows is the gauge by which management, lenders and investors measure the strength of a company’s cash flow. A company’s ability to prepare accurate and timely cash flow statements, plus perform insightful forecasts and analyses derived from those accurate cash flow statements, are crucial for assessing both the current health of the company and making key business decisions.
Effective Cash Management denotes the ability to have a handle on the timing, amount, and predictability of future cash flows, and this function should be an important role for the Chief Financial Officer at all companies, not just in high-growth and highly leveraged organizations. The ability for a company to develop an insightful, strategic and accurate cash flow forecast allows the company to manage scarce resources effectively, as well as provide management, investors and lenders with greater insight and confidence. Improving cash flow management, reporting, analysis and planning will bring the following benefits to an organization:
- Timely insight on forecast cash levels and cash position.
- The ability to make proactive impactful decisions with more accurate information.
- Provide quicker decisions on operating results and performance.
- The ability to perform timely what-if analysis for evaluating business options and scenarios.
It is typical for companies to invest working capital before realizing a profit or return on investment. Consequently, inaccurate and infrequent cash flow analyses can lead to a misunderstanding of the timing of cash flows, which can negatively impact how a company’s financial performance will be viewed by both internal and external stakeholders. This could impact critical components of a company’s growth strategy, such as the ability to raise capital or pursue acquisitions. On the other hand, better management of cash flow can positively influence how customers view the viability of the organization, such as brand recognition and new product/service offerings, and therefore influence whether they buy the company’s products or services.
Investors also place strong reliance on the statement of cash flows, whereby a positive cash flow driven by core operations is a healthy sign for most investors. This is an indication to the investors that the ability to increase purchasing for both inventory and capital assets is an organization’s commitment to future growth, dividend payments, and the ability to survive during weak economies. Under specific circumstances, an unfavorable cash flow position in not always a negative reflection on a company. At times, a negative cash position can signify new product development or other business expansion which is needed for long-term market growth. This is typical within high growth markets or industries, like software development, biotechnology, etc. However, in these industries, it is even more critical that effective cash management strategies are in place to identify the need and timing of “life-sustaining” cash infusions.
The Bottom Line
Like so much in the world of finance, the statement of cash flows is simply a piece of the puzzle. Understanding it together with the other financial statements will provide management with a more complete picture of the company’s financial health. However, no matter how profitable a company may be, if it does not have the cash to pay its bills over an extended period of time, it will be in serious trouble.