Cash is King: Cash Flow Made Simple

How can a hugely profitable company fall behind on its rent? When is winning a large contract bad for your business? The explanation behind these perplexing questions is a business concept called cash flow. I mentioned cash flow before, when I talked about making projections for your business, but never explained how cash flow can impact a business’ day-to-day operations.

As you will soon learn, however, there’s a good reason why so many business experts agree: “cash is king.” 



Simply put, cash flow is the interaction between the money coming into the company and the money going out. Unlike a profit and loss statement, which measures how profitable a company has been, a cash flow statement cares much more about the actual cash available for paying staff and keeping the landlord happy.



To answer our original conundrum about a profitable company that can’t pay its bills, we must first understand two accounting terms: accounts receivable and accounts payable. Accounts receivable is simply a term used for money that a business is owed (e.g., a customer that will pay upon delivery), while accounts payable refers to money the business owes to, say, a supplier who has agreed to accept payment after 30 days.

A lag between when your bills must be paid and your customers send a check can make it hard to cover those obligations.



Let’s use Tony’s Construction Inc. as an example of a company that, while technically profitable, will quickly find itself in trouble because of poor cash flow management.

Tony is a well-established home improvement contractor with a steady stream of revenue from relatively small jobs. In an effort to grow his business, Tony bids and, to his delight, wins a major contract to renovate a school. Tony hires additional workers, purchases materials, and invests in some new equipment he will need to fulfill the contract. However, the agreement with the school stipulates that Tony will receive the bulk of the money upon completion of the job, and Tony quickly runs out of funds to pay his workers and buy more material. Without workers or materials, Tony is forced to give up the contract and take a crippling loss. In the excitement of winning the bid, Tony failed to consider the impact such a large contract could have on his cash reserves.



Depending on the industry, a change in season can also have a huge impact on cash flow. A few years back, I worked with several Coney Island businesses and was shocked by their financial statements. It’s not rare for a business on the boardwalk to rely on four weekends (Labor Day, 4th of July, Mermaid Parade, and Memorial Day) to make 80% of its sales. Imagine the discipline and foresight required to run a business that makes almost no money for 354 days out of the year.

Sure, these businesses are extreme cases, but they provide a valuable lesson for all business owner: understanding how and when money flows in and out of your business can be the difference between a successful enterprise and one that struggles to pay its bills.



The bottom line is that managing cash flow can make or break a business. The most profitable business in the world can quickly find itself in trouble by simply running out of cash.

How can a business owner avoid this fate? One solution is applying for a line of credit, which can be used to cover immediate expenses before account receivables come in. Another is to renegotiate terms with your customers or suppliers. The goal of these negotiations is to ensure your customers pay as early in the process as possible (taking a deposit can help) and your suppliers agree to be paid as late as possible. Ultimately, however, healthy cash flow requires foresight and preparation. Those business owners who can see potential pitfalls coming and prepare accordingly will keep their bank account healthy and their landlord happy.

For more cash flow and financial management tips, use the tags on the right to find additional articles. 

Manuel Dominguez is the Director of the NYC Business Solutions Centers in Brooklyn. If you have a question or comment for Manny, drop him a note below. And, please share this blog entry with your colleagues on Facebook, Twitter, LinkedIn, email, and your favorite social media sites.