For the layman, operating a business seems easy. If you make more than you spend, you’re successful. Right?
In reality, even companies that are making great profits are actually setting themselves up for failure. It happens all the time. You’ll see a great new company skyrocketing its profits to the moon, and then it will suddenly be closing its doors. A failure to be learned from.
So, why is that? Well, it usually has to do with cash flow mismanagement. The finances of a company are far more complicated than “make a profit and get rich”. Every little detail has to be accounted for.
Here’s an in-depth dive into why cash flow management is important for middle-market businesses.
What is Cash Flow Management?
Cash flow management is a fairly simple concept that gets incredibly deep when you actually dive into it. At its most basic level, it’s simply the analysis and optimization of how your money is coming in and going out.
This is a daily activity that will persist throughout the entire lifetime of your business. It’s not just something you do every once in a while when you notice a problem. Thus, it’s a demanding task, and that’s usually why companies fail to consider it as much as they should.
What is the Goal of Cash Flow Management?
The goal of cash flow management goes well beyond tracking your money and making sure you’re making a profit.
First, it’s how you make sure you have the funds to meet your needs in the future. With cash flow management, you determine not only how much you have now, but you use projections to determine if you’ll have the funding to pay all your bills a month, a quarter, or even a year from now.
That helps prevent sudden financial issues with your business.
Then, it’s also used to optimize the way cash is coming and going. Not all profits are the same, but we’ll talk about that shortly.
Why isn’t Profit Enough?
Why isn’t profit enough to be considered a success? We touched on it briefly, but it’s more complicated than that.
We’ll use the worst type of example. Imagine a company that is about 3 years old, and has made tremendous profits the entire time. However, when you look into it, the company is doing it by cutting corners, mishandling its employees, not reinvesting in itself, and generally, just focusing on how big the profit is each quarter while everything else falls to the wayside.
Sure, the company is profiting, but what happens when employees start quitting without replacements, equipment starts breaking and affecting productivity, and customers stop buying shoddy products? Well, that company that was doing amazing fell apart suddenly.
It’s not always as extreme as that, though. In fact, we hope you’re not in that situation. Sometimes, it can be as simple as having profits because you’re not reinvesting money, and in the long term, you’re simply not growing. Thus, you fizzle out when a bigger, more savvy, competitor comes along.
Benefits of Cash Flow Management Beyond Profits
Cash flow management goes much deeper than simple profit tracking, and there are a lot of benefits to using it properly.
Here are the key benefits you get when you properly manage your cash flow.
1: Elimination of Debt
Businesses take on debt when they either don’t have enough money on hand to pay for their basic needs themselves or when they make massive purchases that simply aren’t practical to make with cash.
Cash flow management helps with both those problems to eliminate your need to take on debt.
The focus of cash flow management is making sure you have the money to pay for what you need and the day-to-day operations of your company. When you successfully do that, you don’t need to take out a loan to pay your overhead or cover sudden repairs for necessary equipment. You have it on hand, and you’re able to take the financial hit yourself.
While it’s never fun to be forced to spend your money, it’s a lot better to know you personally have the funds to cover necessary expenses instead of having to pay back someone else over a period of time.
This also ensures that, as you open more room in your budget, you can keep money stored for bigger purchases that you need to take on to grow. Allowing you to minimize the debt taken to make those key purchases or eliminate it altogether.
Now, creating a budget that allows you to absorb massive purchases without your bottom line being affected isn’t something everyone will be able to do. Occasionally, debt is going to be taken on. However, it shouldn’t be taken on for basic operations, and that’s where cash flow management really shines.
2: Reducing Accrued Debt
To understand why cash flow management is important for middle-market businesses, you need to understand the fact that for most business owners, debt is already an issue to some extent. You might not be in over your head, but you probably have a loan here or there that needs to be paid.
Since cash flow management helps you get better control over your financial situation in general, it’s the first step to reducing the amount of debt you already have. As you optimize your cash flow to take care of your necessary expenses and encourage more money to come in, you can stop the debt from increasing, pay on it regularly without impacting your business, and eventually, pay it off.
3: Finding Money Holes
Even highly profitable businesses are typically wasting money somewhere along the line. You probably are, too.
Pretend you’re a restaurant owner, and you’re making tremendous profits. You don’t look at your cash flow too much, because everything seems to be going great.
However, you have a dish on your menu that requires unique ingredients not used elsewhere on your menu, slows productivity every time it’s ordered, and only a couple of people order it per week.
That’s a money hole, and it’s a problem that many restaurants deal with. If you were managing your cash flow, you’d see that expense, see how little is coming in from it, and know that it’s not a necessary item for your target audience.
Thus, you suddenly get to remove all the unique ingredients needed to make it, it doesn’t slow down your kitchen’s productivity, and there is practically no impact on your customer base or reputation.
That’s not a problem unique to the restaurant industry. Most businesses are wasting money somewhere, and cash flow management allows you to pinpoint those areas and work to resolve the issue.
This adds a ton more money back into your pocket because since you’re no longer wasting it, and it didn’t decrease your overall earnings, it’s essentially more profit.
4: Redirecting Resources
Sometimes, you don’t have to get rid of anything. Sometimes, you actually have an underperforming aspect of your business that could impact it greatly if you just diverted more resources to it. Which, in turn, would increase your profits and general financial health.
In the same way, cash flow management can help you spot areas where you’re wasting money, it can show you where you’re able to spend a little more for a dramatically more impressive effect.
For this example, we’ll keep it simple. You operate a retail toy company, and you’re making plenty of money, but when you go over your cash flow management records, you see that a certain toy from one brand is selling out almost immediately when it hits the shelves, and it’s providing a sizable ROI.
However, you notice that a couple of other toys are costing you a fair amount, but they take a month or more to run out on the shelves, and you’ve given them a ton of aisle space.
With cash flow management, you can see how much money you were making and how quickly from the toy that’s never in stock, stop buying as much of the one that isn’t selling as well, reduce its shelf space, and instead pump both those resources into the toy that’s always out of stock. Now, you’re suddenly generating a lot more sales in a shorter amount of time.
When you just look at the big number labeled profits, you don’t see those little opportunities that have a big impact. You just see if you’re staying above water and getting something to show for your effort.
5: Peace of Mind
Operating a business is extremely stressful, sometimes even more than selling a business. You have a lot of obligations to attend to both financially and in terms of actual labor, and it all adds up. Primarily, you have to worry about the short-term and long-term needs of your company.
If you’re profiting, you’re alright in the short term, and that’s why a lot of businesses that fail don’t take action long before the actual signs of failure show.
Cash flow management’s effect on your long-term financial health is where it tends to shine a lot. Because you’re working on optimizing your financial health, and you’re making better decisions, you also look at the long-term requirements of your company and what you’ll need to fulfill those requirements.
A lot of this involves projecting what your future financial health and expenses will be based on what your financial health is now and the plans you have for the future.
Are you expanding your business but barely have enough to cover your overhead at the moment? You might have great cash flow now, but you might not be on track for a good financial future. What do you need to do to get on track?
Those are questions you answer with cash flow management, and in doing so, you not only help your business thrive, but you reduce the amount of stress you and your team deal with, as well. You’re not as easily caught off guard by unexpected expenses or growth attempts underperforming.
How is Cash Flow Management Handled?
Cash flow management is a process that includes a few steps. For the most part, it all comes down to recording, analyzing, and improving your decision-making skills.
All of your transactions, both with money coming in and going out, should be recorded by default. Even if you’re not focusing on cash flow management. So, the recording aspect of it is mostly handled if you’re doing things right as a business professional.
Then, there’s the analytical aspect of cash flow management. You need to regularly sit down, and look at where your money is coming from and where it is going.
Throughout this process, you’ll look to identify what areas of your business are performing optimally, what needs more resources to provide better results, and what needs to be minimized or eliminated as soon as possible.
Finally, the last step is to take all that information and take action on it. This is where you make changes such as eliminating underperforming products or services, directing more cash flow and resources to areas that could use a boost with almost guaranteed results, and figuring out how you’re going to be prepared for the long-term.
Other decisions come into play, too. Debt is usually supposed to be avoided, but in business, you’ll likely want to take it on. During your cash management process, you’ll want to make good decisions regarding when it’s best to leverage credit lines and debt, and when you need to find another way.
Negotiating your contracts, debt negotiations, and other aspects of your business would also be considered cash flow management because you’re actively trying to manage those sources of income or expenses to be more favorable for your overall financial health.
Don’t Handle It Alone
Now that you’re aware of why cash flow management is important for middle-market businesses, you understand that it can get very deep. It’s a simplistic topic on the surface, but each little factor breaks down into a million smaller things to consider, and each thing usually requires you to weigh the pros and cons of every possible decision.
That can be a lot for you to handle unless you have a dedicated financial team, and many middle-market businesses don’t have that luxury.
Final Ascent’s M&A advisors are here to help. We specialize in helping middle-market businesses succeed. We’re here to make sure your experience as a business professional is the best possible one.
Contact us today.