Business mentor and angel investor Mark Lyttleton knows what it takes to build and grow a successful business. This article will explore the issue of cashflow and why it is so important for companies of all ages and sizes to benefit from sufficient investment to support short and long-term goals.
Cashflow and profits are crucial elements of any business. For any enterprise to be successful in the long-term, it must generate profits while simultaneously operating with positive cashflow.
Cashflow is a term that describes the inflow and outflow of money to and from a business. It is vital for daily operations, including meeting operating costs, paying employees and purchasing inventory, as well as funding one-off expenditures such as investing in new premises or upgrading equipment.
A positive cashflow indicates that the liquid assets of a business are increasing, enabling it to settle debts, pay expenses, return money to shareholders and reinvest in the business. Positive cashflow provides an important buffer against unanticipated financial challenges. Negative cashflow, on the other hand, indicates that a business’s liquid assets are decreasing.
Profit is the surplus after deduction of all expenses from revenue. It is the yield generated by a company and is used as a basis for the calculation of taxes.
As a general rule of thumb, financial experts recommend that a business maintains a sufficient cash reserve to fund a minimum of 9 to 12 months of operations. Unfortunately, for early-stage companies in particular, revenue growth can be difficult to predict. Perhaps a new product released by the company will fail to gain traction, or the market could see an unanticipated downturn. Private companies need to maintain sufficient cash to enable them to remain operational should they encounter unexpected difficulties.
Building a financial buffer better prepares companies for a cashflow crunch. In recent years, uncertainty is a predominant mood that continues to run through many business arenas. Between a tumultuous global economy and high employee turnover, remaining competitive has become extremely challenging for many small to mid-sized enterprises. However, in terms of placing themselves in the best possible position to weather any economic storm the future may hold, creating a cash buffer is one of the single most important steps a business can take.
Also known as a reserve fund or cash reserve, a cash buffer essentially serves as a piggy bank that can be raided on a rainy day. A recent study by Harvard Business Review highlighted the importance of maintaining a healthy cash buffer, suggesting that businesses with a buffer covering two months or less of operations struggled to remain operational. Fluctuations in seasonal sales and market downturns can take their toll. However, one of the most common causes of cash shortfalls is inaccurate forecasting.
It is crucial for companies to take the time to develop a realistic cashflow forecast, allocating funds and calculating payables and receivables to help management map out a future financial trajectory. Of course, it is impossible to predict every single expense that could come a company’s way. However, preparing a cashflow forecast and building an appropriate financial buffer helps businesses to futureproof themselves.
Maintaining an ample cash buffer enables companies to cover unexpected expenses, protecting their liquidity during a cashflow crunch and reducing the risk of financial anxiety – or an interruption in business operations – purely due to a short-term lack of funds.
