Why is Cash King? Why Does Cash Matter?

 

 

“Cash is king” is an age-old saying often used to explain the failures of businesses. Without the proper amount of cash on hand, you can run into significant trouble and even be forced to close or bankrupt.

Moreover, a business’s cash flow is often cited as a critical factor in its potential for long-term success. A company may have all the revenue globally, but it can quickly fail without the ability to generate cash.

Monitoring Cash

The statement of cash flows reveals where you are and provides you a basis for managing cash. It shows changes in balance sheet items from one accounting period to the next, and special attention should be given to significant balance changes.

Continually reporting negative cash flows from your operations is a signal of danger. There is a limit to how much money your company can get from selling off its assets, issuing new stock, or taking on more debt.

A red flag should go up when operating cash outflows consistently outpace operating inflows. It can signal weaknesses like out-of-control growth, poor inventory management, mounting costs, and weak customer demand.

 

Categorizing cash flows

 

The statement of cash flows typically consists of three sections:

1. Cash flows from operations. This section converts accrual net income to cash provided or used by functions. All income-related items flow through this part of the cash flow statement, such as net income; gains (or losses) on asset sales; depreciation and amortization; and net changes in accounts receivable, inventory, prepaid assets, accrued expenses, and payables.

 

2. Cash flows from investing activities. The transaction shows up here if a company buys or sells the property, equipment, or marketable securities. This section could reveal whether a company is divesting assets for emergency funds or whether it’s reinvesting in future operations.

 

3. Cash flows from financing activities. Cash flow statements show transactions with investors and lenders. Examples include Treasury stock purchases, additional capital contributions, debt issuances and payoffs, and dividend payments.

 

Below these three categories are the schedule of noncash investing and financing transactions. This portion of the cash flow statement summarizes significant transactions in which cash did not directly change hands: for example, like-kind exchanges or assets purchased directly with loan proceeds.

 

Knowing Cash Accessibility

 

Cash accessibility, in my view, is the most important thing to look at in evaluating business performance. Companies not only require net positive cash flow to operate sustainably, but they need that positive cash to be visible and as cheap and straightforward as possible to deploy.

 

Cash accessibility isn’t the same thing as free cash flow (i.e., the difference between operating cash flow and capital expenditures), although free cash flow is certainly a component of it. In some situations, your company temporarily lacks liquidity or doesn’t have a significant amount of free cash to distribute because it has invested that cash in its business.

 

In other instances, your company’s cash inflows outpace its outflows. However, money can end up in places where banking laws, export controls, and currency restrictions make it impossible to deploy it effectively.

 

Managing to Grow

 

Regardless of the challenges you are facing, committing to the fundamentals will yield results.

1. Cash Flow

For you to survive, cash flow is the single most important financial factor. A company could have fantastic revenue, reasonable expenses, and significant income, but if its financial operations are not designed efficiently, it could still have negative cash flow.

And without positive cash flow, your business will go bankrupt no matter how promising the business model is. But eventually, your organization must focus on creating positive cash flow. Without it, a company will not even accomplish the simplest of tasks: paying its monthly expenses.

 

2. Capital Expenditure Investments

 

To grow, you will need to invest in property, equipment, or technology, and these are typically one-time costs that require significant funds. Without cash on hand, a business may not be able to make these necessary investments and, as a result, may slow growth.

Sure, you can take out a loan, but even a loan will require a significant down payment, which will, in turn, require you have access to cash. Loans also come with interest rates that can further eat into your company’s bottom line.

3. Emergency Preparation

 

You will face emergencies where you need to pay expenses right away, including legal fees and unexpected costs associated with natural disasters. Since these fees are not planned, therefore not incorporated into your company’s budget, businesses must have access to the necessary cash when such situations arise.

 

4. Cuts Transaction Costs

 

It would be best if you kept your expenses as low as possible. Businesses can cut back on these fees by paying with actual cash, significantly reducing their costs and increasing their bottom-line profits.

 

5. Helps Businesses Expand in the Absence of Loans

 

Many businesses have had to learn the hard way that lenders are becoming more thrifty with how they loan money. If a company has cash available, it can better take advantage of opportunities to expand and make significant acquisitions – options that may otherwise not be available in the absence of loans.

 

Develop Cash Flow Projections

 

A significant first step is to develop a rolling 3-month cash flow projection (or cash flow forecast depending on the data you have) to get a picture of what cash flow looks like today and what it may look like in the coming weeks.

Your cash flow projections will help you predict shortfalls, so you can plan and act when necessary. This 3-month model is used by many turnaround advisors to keep a close watch on the pulse of an organization.

Why 3-months? This time horizon is short enough to support agile, tactical decision-making but provides a long enough view to drive longer-term decisions. It strikes a balance between accuracy and range.

The 3-month cash flow projection is not meant to be an exact measure of your company’s cash balance at the end of every week. Actual results will vary from your point, especially in the last weeks, but the projections will help identify where your cash balances are trending.

A 3-month time period provides enough horizon to impact strategic decision-making while remaining short-term enough to give a degree of accuracy.
If updated weekly, rolling, the 3-month cash flow projection becomes a powerful tool to identify changing needs and anticipate how and when liquidity shortfalls could occur.

It, therefore, offers companies the ability to prepare for, if not rectify, issues before they materialize.

Another benefit of the 3-month cash projection is that it is often a requirement for bank reporting or lending requests.

 

Conclusion

 

Your success will be determined by how well you execute your plan. If you stop focusing on your cash flow, daily monitoring of your metrics or lose track of where your sales are, your recovery/reopening will not yield your planned results.

Stick to the plan. Insist on accountability. You will move into profitability. Just monitor and adjust when necessary. You will win!

Plan! Adapt! Manage! Succeed!

How to win BIG! Contact AccuComp Enterprises CFO team. 

We know how to help you grow!

Learn more by chatting at: https://www.accucompenterprises.com/lets-chat/.

If you prefer, email:  r.margallo@accucompenterprises.com.