The most frequent answer I get is profit.
Profit is a short term view of assessing the health and wealth of a business. Unless you want to stay in business for the short term, don’t focus on profit alone. The most important word in business is not profit, but cash flow.
Yet, many entrepreneurs strongly believe that profit is the most important word in business. But according to management guru Peter Drucker, this shouldn’t be so. In his all time management classic book; ‘The Essential Drucker’, he states;
“Entrepreneurs starting new ventures are rarely unmindful of money; on the contrary, they tend to be greedy. They therefore focus on profits. But this is the wrong focus for a new venture, or rather, it should come last rather than first.
Cash flow, capital and control should be emphasized in the early stages. Without them, the profit figures are fiction –good for twelve to eighteen months, perhaps, after which they evaporate.
Growth has to be fed. In financial terms, this means adding financial resources rather than taking them out. Growth needs more cash and more capital. If the growing new venture shows a “profit”, it is a fiction: a bookkeeping entry put in only to balance the accounts…the healthier a new venture and the faster it grows, the more financial feeding it requires.”
Cash flow is the Most Important Word in Business
The understanding of cash flow management is key to the survival of any business. As my financial mentor Robert Kiyosaki always says, ‘the direction of your cash flow is everything’.
Successful entrepreneurs know that one of their key functions is to know how to manage the available resources and at the same time galvanize the available resources towards achieving the desired result.
This is what Peter Drucker above referred to as “feeding growth” and for growth to be fed, you need to understand cash flow.
What Is Cash flow?
Cash flow is the movement of money in and out of your business. It is the direction from which revenue is generated and the direction through which revenue is spent. Cash flow is the inflow and outflow of cash inside your business. The whole concept is hinged upon two words; income (receivables) and expenditure (payables).
Cash flow is the measure of cash that flow in and out of your business. Cash flow is the life wire of any business. What blood is to the body is what cash flow is to the business. When blood stops flowing into your system then you’re on your way to the mortuary. Cash flow is simply the life blood of any viable business.
Your responsibility as an entrepreneur is to ensure that more cash flows into your business than goes out of your business. It is the maintenance of a positive cash flow in your business that determines the financial health of your business.
This is the reason you must always ensure that more cash flow into your business than what’s going out of your business. When more cash flows in than goes out, you will have a positive cash flow. But when more cash flows out than comes in, you will have a negative cash flow.
Why is Cash flow so Important In Business?
1) To Stay Alive
What’s the resultant effect of failure of blood circulation in the system? It is death.
So when a business is not maintaining a positive cash flow, it can lead to the death of that business. While it is possible for your business to record loses and still survive, a profitable business with a negative cash flow can never survive. This is one of the major reasons most businesses never survive more than the first five years from inception.
While profit is calculated at the end of a particular business period, cash flow is ongoing. In a typical business, everyday money comes in and money goes out. You make and spend money in your business daily. Cash flow is how you determine whether your business is healthy and wealthy.
2) Without cash flow there can be no profit
Profit is made when products/services are sold. Until you sell, you can’t expect profit. But you need money to create what you sell. Ensuring the continuous availability of that money is the essence of cash flow. It is obvious that you can only spend after you earn, so it is important you earn more than you spend.
Businesses that are wealthy focus on improving their cash flow not just profitability. They focus on how fast they are turning their products/services into cash, how else they can improve on their operations to lower cost, and what else they can do to increase their sources of income.
If your business is slowly generating cash, you will struggle financially regardless of the profit you make.
3) Financial Analysis
Income (receivables): how frequent does money come in and how consistent is it?
Expenditure (payables): how frequent does money go out and how consistent is it?
You are running a wealthy and healthy business if you have more money coming in frequently and consistently than the money going out.
Businesses that often have money readily available are healthy and wealthy business. But a business that lacks liquid cash due to the infrequent and inconsistent inflow of income, such a business is unhealthy and struggling financially.
4) Financial Forecasts
Every business should know twelve months ahead of time how much cash it will need, when and for what purposes.
And when it comes to cash flow forecasting, there’s an old banker’s rule of thumb you should always apply.
- Income (receivables): always assume that expected incomes will come in 60 days later than as at when due.
- Expenditure: (payables): always assume that bills will have to be paid 60 days earlier than as at when due.
Entrepreneurship Demands Financial Management and a good starting point is cash flow management. The lack of adequate financial focus and of the right financial policies is, by contrast, the greatest threat to businesses. The more successful a business is, the more dangerous the lack of financial management.