If your business is growing, then managing cash flow is as critical as managing sales and expenses.
Fast growth and rising profits typically mean thin bank accounts. Growing sales require bigger operating cash balances. More funds are tied up in uncollected receivables and inventory requirements increase. And that says nothing about the need for additional fixed assets. For most businesses, the relationship between sales and the need for assets is stable and predictable, even in dynamic markets. This cause and effect relationship means that as sales grow, operating cash flow drops. The more rapid the rate of growth, the more perverse the behavior of cash flow.
Few entrepreneurs appreciate the difference between operating cash flow and operating profit.
The funds flow statement prepared by accountants are arranged to reflect the sources and uses of funds: operations, investment transactions, financing transactions and dividends or withdrawals. In addition, the most important section of a funds flow statement for a growing company is funds from operations. Funds has multiple definitions for an accountant. For an entrepreneur, it has one – cash.
Beyond the receivables and inventory, more sales mean a bigger minimum cash balance just to cover daily operating transactions.
If you pay your bills promptly, suppliers will help ease the pressure on cash. Trade credit is a spontaneous source of funds for businesses that respect their supplier relationships. As sales grow, trade debt can be expected to grow, too, but never enough to cover the growth in receivables and inventory.
For high growth ventures there is a cause and effect relationship between sales and assets. Understanding that relationship is essential for growing companies. It explains why profits and cash flows move in opposite directions. More importantly, understanding the relationship provides the basis for forecasting the need for new financing well in advance of the day it is needed.
Effects of Rapid Growth
Rapid growth, and focus on maintaining that growth, can dilute the operating expenses of the organisation. In a business where the timing of expenses lag the timing of sales, any business success ratio that relies on gross sales as a denominator will necessarily paint a better picture than is truly the case. Second, the bias toward sales will tend to motivate the organization to assess the success of the business using ratios with gross sales as a denominator. Third, the organization sends a message that operations expenses take a lower priority to sales growth, so process evaluation and feedback systems are not fully developed. As sales volume grows, so do expenses. Often, the expenses grow at a faster rate than sales.
Power to the Business
As the firm grows the banking relationship changes and the balance of power can swing towards the business. Typically the business requires account services in foreign currencies, phone and electronic banking, and more efficient payment and collections products.
Cash management products bundled with lending products, such as working capital loans, can be particularly appealing. And credit is very important.If the business puts its deposits in a bank and does its payments there as well, a lending relationship should be easier to develop.