Tough Times Crown Cash Flow as King


In the previous White Papers of this Educational Series, we outlined two of the five areas where business owners who want to both survive in today’s economic climate and emerge from it poised for growth (or sale) can focus their energies. As you may recall, the areas we have already talked about are creating value and creating revenue. Today, we discuss the third area: quantifying cash flow.
As business owners consider ways to meet today’s economic challenges, a vital first step is to focus on company cash flow.

What do we mean by cash flow? The amount of cash left over after the company has paid its expenses. Common add backs to cash flow include:

  • Excess Compensation
  • Shareholder Distributions
  • Owner Perks
  • Retained Earnings Additions
  • Depreciation and Amortization deductions

We recommend that owners take a hard look at their company’s monthly cash flow statement. Do they really understand what it is telling them? Today every owner must become an expert in reading cash flow statements. If you client is not as comfortable with their company’s financial statements as they are with their favorite novel, they should ask for help. You can quickly teach them to “read” or analyze their financial information so that they can quickly determine, on a monthly basis, their company’s cash flow.

Why is cash flow “king?”

Cash flow has always been hugely important in both running a successful company and in orchestrating its successful sale, but today cash flow is king. Why?

  1. Cash flow is the lifeblood of a company. Owners must understand —and be able to measure —where cash comes from and where it goes. It is an accurate indicator of the financial health of a business. Unlike more subjective measures, it makes no assumptions and entertains no preconceptions.
  2. For the reason stated above, cash flow is a critical component of what a bank wants to see. Unless the owner is able to accurately establish current cash flow, banks will be reluctant to grant or renew financing.
  3. Quantifying exactly how the current economy has affected a company’s cash flow (as opposed to just revenue) provides a credible way for your client to predict the impact of further expense reductions, strategies to improve revenues or strategies to improve gross margins. If the owner does not know —at this moment —their company’s cash flow position, they cannot effectively manage their company and cannot predict or project future cash flow.
  4. The financial reason owners are in business is to grow shareholder value. Shareholder value grows as cash flow increases.
  5. In troubling times, employee fraud (such as embezzlement of company funds) tends to increase. The best way to detect fraud is to review cash flow/financial statements on no less than a monthly basis. We are assuming, of course, that your client’s company is producing monthly financial statements. Anything less frequent than that and they run the risk of not reacting to something that “isn’t quite right” as quickly as they should, and not knowing where their business is or where it’s heading.

Once your client has a handle on current cash flow they need to create, based on today’s economic climate, a projection of future cash flow. Begin with an accurate picture of current cash flow. Then, create three projections: one for the best-case scenario, one for the worst and one for the likeliest scenario. All of those projections should include assumptions about:

  • Customer Expectations/Policies
  • Supplier Options
  • Actions of your Competitors
  • Profitability
  • Pricing
  • Product Lines
  • Equipment Replacement

Keep in mind that the owner’s employees may not be able to create these projections. They may have their hands full managing the day-to-day issues. If that’s the case, they should seek the help of a CPA, or consider hiring someone on a temporary or project basis. These projections are simply too important to put off until next week, next month or next quarter.

In the next White Paper, we will talk about how cash flow can be used as a tool to predict the efficacy of strategies designed to preserve and protect value.

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