Revenue and net income growth are paramount to a company’s success, but cash flow is just as important. In fact, a strong argument can be made that a robust cash flow is the most important factor when it comes to a firm's success or failure. The truth is that a successful company will demonstrate revenue and net income growth as well as positive cash flow. (For more, see: How Can You Use a Cash Flow Statement to Make a Budget?)
From an investing standpoint, it’s important not to look solely at revenue or net income. Revenue numbers can inflate if a company finds new sales streams, including inorganic growth via acquisitions or, if it's a retailer, by opening more locations.
You also have to check how the company is collecting revenue. If it’s not coming in via a timely manner, the firm's cash flow will likely be negatively impacted. It’s also possible that the cost of selling goods and services is high, which will not provide much assistance to cash flow. (For more, see: 10 Ways to Improve Cash Flow.)
When it comes to net income, growth can be shown through the sale of inventory. When looking at net income growth, be sure to read the fine print. If it’s a public company, check its SEC filings.
Cash flow is the most difficult metric to manipulate. Either inflow outweighs outflow or it doesn't. If a company is cash flow positive, the capital is acting as the engine for running the business on a day-to-day basis. (For more, see: The Essentials of Corporate Cash Flow.)
Cash Flow Management
A company that demonstrates good cash flow management will project future cash flows. This is imperative because it will allow management to plan accordingly for future income and expenses, and it will reduce the likelihood of surprises. For example, if cash flow projections indicate a red flag in the near future, liquid assets can be sold to free up cash prior to payments to creditors and/or payroll being late.
Cash flow is even more important when credit is tight. During these times, any shortfalls might lead to more difficulty borrowing money. If a lender sees risk as high, then a company will pay more interest. Failure to pay will result in a hit to a company’s reputation, poor credit quality, higher interest rates on future loans, the potential loss of employees who aren’t paid on time, and bankruptcy. (For more, see: Why Cash Management Is Key to Business Success.)
Regardless of credit markets, it’s imperative for a company to find a way to be cash flow positive, which will help stave off the scenario above. A company that is cash flow positive will likely earn a strong reputation, the ability to secure top talent, good credit, and lower interest rates on loans.
Positive Cash Flow Benefits
If you’re looking at a company from the outside and you want to dig deeper to determine its health, look at competitors' cash flow statements. If the firm's cash flow is positive and more robust than that of its peers, management is doing a good job and its overall health is good. It also means the company will have the ability to be proactive rather than reactive in the way it does business. Below are several benefits to being cash flow positive:
Improving Cash Flow
If your business is having cash flow problems and you want to see things improve, read on for some strategic ideas to try.
Use Cash Flow Management Software
Instead of hiring a finance expert to do the work, have it automated. The downside is that the economy changes in dynamic fashion and cash flow management software might not be able to adjust as quickly as a certified financial planner could. A CFP will be able to see certain changes more quickly, including things that impact taxes and interest rates. However, cash flow management software is still in its early stages and we will likely see more advanced technology in the future. (For related reading, see: Debunking Robo-Advisor Myths.)
Renegotiate with Suppliers
If you’re in good standing with suppliers, ask to change a payment date or two. By extending these deadlines out by a few more days, you will have an opportunity to improve cash flow.
Sell Unnecessary Inventory
This doesn’t just pertain to inventory that doesn’t move, it can also apply to low-margin inventory. The vast majority of capital going toward product sales should be put specifically toward products that consistently see the highest demand. (For related reading, see: 6 Tech Trends Advisors Must Stay Ahead Of.)
The easiest way to do this is to upgrade old products or services. To increase sales, raise the price on the older version to somewhere not quite as high as the new version, so consumers will see more value in buying the higher-priced item. Also consider increasing prices on other items, especially accessories and parts. Consumers don’t pay as much attention to price increases on these items, which means volume isn’t likely to be hit much. This, in turn, should lead to improved margins and cash flow.
If a customer is past due on a payment, offer a discount if that he/she pays in full immediately. This will provide an immediate boost to cash flow.
Ask for Deposits
When you ask customers for deposits, they usually pay them. This is one of the simplest yet most effective ways to increase cash flow. (For related reading, see: How Do Venture Capitalists View Sustainable Growth in a Startup?)
Collect Automated Electronic Payments
Investing in an electronic payment system allows you to receive regular, on-time payments from clients.
Outsource Where You Can
Outsourcing probably doesn't apply to every aspect of your business — only areas where you wouldn't see a steep decline in quality. Never sacrifice quality to cut costs. (For more, see: Outsourcing vs. Subcontracting.)
Pay Bills on Time
Do not pay bills early! This will increase the speed of your outflow, which will reduce cash flow. Instead, set up an automated system where you’re paying bills on the due date. This will keep more capital in the business for a longer period of time.
Build Good Relationships With Suppliers
Keep communication lines open and don’t hesitate to take a supplier to dinner, to a sporting event, or to a show. By forming a relationship, you’re greatly increasing the odds of effective negotiations—ones that will likely impact your cash flow — in the future. (For related reading, see: Tips for Winning Wealthy Clients.)
The Bottom Line
Positive cash flow is imperative to a company’s success. If a business doesn’t have enough in receivables, it will fail in payables, which will eventually lead to a downward spiral. Fortunately, there are many ways to help improve cash flow. (For related reading, see: How to Exit Your Small Business Gracefully.)