Frankly, this is really too important a topic for what is supposed to be a relatively light-hearted business blog - it is also in danger of turning into a rant, so I will keep it simple.
On my course I tend to ask the simple question 'what is cashflow?' this is often met by quizzical looks - either because it's a stupid question (the rule is there is no such thing as a stupid question, so that's out), or because people simply don't know. Often, the response comes along the lines of 'it's profit' or 'it's the same as turnover' which, in the context of business success is deeply alarming.
So, in a nutshell, turnover and profit are paper or accounting functions - they are not real money. Cashflow is real, hard money. Some simple examples (ignoring concepts like fixed and variable cost):
XYZ engineering sells specialist components to K Motors for £1000. Their buy-in cost is £400 which must be paid up front. XYZ agree to pay on 30 days, but in reality will aim to spin that out to 60 or even 90 days.
Whereas Super-Dupermarket buys a job lot of carrots from Farmer Palmer for £1000 and sells them within a week for cash at £1,200. They won't pay Farmer Palmer for 90 days.
So, who has the best business? XYZ are the more profitable by quite a wide margin, but they are also the ones who are likely to go bust - because they don't have any cash!
Superdupermarket can re-invest Farmer Palmer's money up to 13 times before they have to pay him, whilst XYZ are funding an overdraft (or factoring facility) whilst they are waiting for payment and, effectively bankrolling K Motors' business.
Pretty obvious in theory, isn't it, but as long as K motors are OK and are going to pay, why should you worry?
You should worry because:
1. However good your credit checking, there is always a risk that K motors won't pay, in which case you lose not just your profit but your capital input.
2. Cash is more valuable than profit.
To use a harsh analogy:
Losses are like cancer - they will kill you slowly. Cahflow is a heart-attack - it can kill you instantly.
One of the most constantly naive assumptions we see on business plans is that customers will pay on time (indeed that they will agree to your credit terms in the first place), thus we are presented by healthy looking cashflows which show goods being bought on 30 day trade terms, and customers paying on 30 day trade terms, so in context of 'stress testing' - you are a new business, what if you can't get trade terms? And what if your customer (assuming they agree to 30 days which most supermarkets, for example, won't) then doesn't pay for 60 or even 90 days (which is by no means uncommon) - does the cashflow still work?
There are many issues here - forecasting, negotiation, credit/collection procedures but far and away the most important facet in business is that cashflow is everything!
Sorry, I'll try to be more jolly tomorrow.
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