why is cash flow important

If a business could be likened to the human body, cash would be the oxygen blood transports to our cells. Like bodies with oxygen, businesses can function without an inflow of money for a little while; however, a prolonged shortage can cause the whole system to break down. The current global pandemic has made it incredibly challenging for businesses to maintain their cash flow. With half of the small businesses claiming that they wouldn’t survive three months of the pandemic, it can be alarming to consider the hit your business’s cash flow and liquidity may take from this disaster and the recession it might cause. However, careful planning provides the only viable solution to this unforeseen catastrophe.

Cash Flow Explained

Cash flow refers to the amount of cash and currency equivalents coming in and flowing out of business. Creating value — and eventually, profit — for shareholders requires a company to have a positive cash flow. This entails more money coming in than being spent on the running of business operations. A positive cash flow (or equivalent surplus) means that a company can increase its cash reserves. This generally leads to additional investment in a company, profit shares, and dividends being paid out to shareholders, and the availability of funds to clear future credit payments.

There are three purposes to cash flow:

  • Operations
  • Investment
  • Financing

Operating cash flow refers to the money flowing in and out as the result of business activities. This number is generally positive. Investing cash flow includes the purchases of assets to increase business capital, as well as a company’s investments in other businesses. Financing cash flow, which is usually only a feature of large companies, includes the profits earned through the issuing of debt, sale of equity, and company payments.

The Primary Uses Of Cash Flow

Cash flow forecasting is a pillar of financial reporting because it allows a company to assess and predict its future liquidity and flexibility. It will enable a business to gauge how much its financial performance can contribute to its expansion, diversification, product or service innovation, and overall survival.

A positive cash flow signals an increase in a company’s liquid assets, which allows it to gain the flexibility required to adapt to sudden market changes and take advantage of resulting profitable investments. Without this margin of movement, businesses can rarely survive market fluctuations beyond three years. A U.S. Bank study found that 82% of failed businesses named cash flow problems as one of the causes of their failure. This highlights the importance of precise forecasting: a negative cash flow is a crucial warning sign of troubles ahead. When suppliers request payment, salaries cannot be paid, and landlords announce your impending eviction, a negative cash flow will prevent you from accessing the loans you may need to save your business. As your business’s cash flow is directly linked to your credit score, proper management is vital; and it begins with accurate forecasting.

Effects Of Poor Cash Flow On A Business’s Performance

To understand how impactful even a couple of months of poor cash flow may be, consider the operational systems of most American businesses. There are currently about 28.8 million small businesses across the country, which account for almost 60 million jobs nationwide. These small businesses rely on the inflow of cash through their daily operations to pay their bills, salaries, and promotional costs. Diminishing cash flow can compromise a business’s ability to pay suppliers on time or settle debts from accumulating bills — leading to additional late payment fees. This can both sink your credit rating and jeopardize your relationship with your landlords, utility providers, and suppliers.

An economic crisis, such as the current global lockdown, can completely interrupt cash flow. Unless reserves are existent, this can halter a business’s growth significantly. A business with no cash flow cannot purchase new capital assets, hire new employees, or benefit from the bulk-buy discounts suppliers often offer upon advance payments. This can drag the business down in a variety of ways — by dampening employee morale, scaring off potential and current investors, and making an evolving market product or service trends unavailable to the company.

Improving Your Cash Flow Amidst A Potential Recession

Emergency funding opportunities are available for small business owners struggling to keep their business afloat during the current pandemic. You may currently qualify from the following programs:

But beyond the quick fixes, the funds they may provide will need a real strategy to increase the positive inflow of cash in your company. In an economic recession and period of necessary social distancing, you will still need to keep in touch with customers and ensure you have collected all you are owed from past credits. You will also want to reach arrangements with your suppliers to extend your credit terms past the state of emergency. eCapital Advisors can also assist your business with systems to support the executive finance department. Technology and information will be necessary for companies to prepare appropriately for a potential recession.

If you’re looking for help managing your cash flow, or reliable cash flow forecasting, our team of expert analysts will be happy to come to your assistance. In these uncertain times, insightful decision-making is your best protection against an economic threat to your business.