Cash is King

Cash is King

Reading time: 3 - 6 minutes

If you’re in business then you have likely heard the saying, “Profit is important but cash is King”.

And, generally speaking, we agree that cash is often the most determining factor in the success or failure of a business.

As any professional business advisor or accountant will tell you, you can be profitable but without cash your business will struggle. But first, let's calibrate ourselves about what the difference is between cash and profit as both are crucially important for a business to be successful in the long term.

Actually, at the time of writing this, there is talk about our future cashless societies being advanced owing to the health risks of handling physical cash. For the purposes of this article, when we refer to cash, we’re talking primarily about cash flow.

 

So, what’s cash flow?

Cash flow is the money flowing in and out of a business. This is the lifeblood needed to fund daily operations such as wages, purchasing inventory, taxes and other operating costs.

A business with a positive cash flow means it can pay its bills, expenses and increase its liquid assets to provide protection against future financial challenges that can arise.

Think about major events in recent times such as bush fires, floods or pandemics. The benefits of having a financial buffer have never been more readily demonstrated.

On the flip side, if a business has a negative cash flow then it’s liquidity is decreasing and that’s not a fun place to operate. Trouble is not far away.

Okay. Thats cash flow. What about profit?

In simple terms, profit is what’s left after you deduct all of the businesses expenses from the revenue. It can be thought of this way, the profit of a business provides an overall picture of its health and is the metric on which the ATO will take their portion.

There are generally three types of profit that can be used to analyse a business but, in this article we are focusing on cash flow, so let’s stay on track.

 

The million dollar question…

Which is more important to a business; cash flow or profit?

Well, when determining which one is King, there are variables and the type of business and its circumstances become important considerations that any professional accountant will advise their clients about. 

As an overarching statement before we dive into the weeds a little; all good businesses are managed such that they are both profitable and enjoy a positive cash flow. And there’s an unavoidable correlation between the two.

Take this as an example. Let’s say ‘Company A’ makes a profit every month but, its cash is tied up in accounts receivables. This could mean that there’s insufficient money to pay wages. But once the overdue accounts pay their invoices cash flows into the business and the employees can be paid. In this case you can see the importance of cash flow to keep the business running compared to profit.

However. Imagine a business that has increased cash flow but is carrying large overheads or debt. In this case they are not profitable and, over time, that has a declining effect on their cash flow. 

 

So back to the question of this article, is Cash King?

To answer it more succinctly, we’ve discussed the importance of cash flow for a company to survive. But why else would we, or any other professional business advisor or accountant counsel our clients about the levels of cash they should have available?

Here’s a few examples that we find are common across most industries.

 

1 - Capital Expenditure Investments

For a company to grow there is often a need to invest in equipment, real estate, technology etc. If there are insufficient cash funds available then either these investments can’t be made or a loan facility needs to be secured. But, loan facilities are not free and often require down payments which brings us back to the topic of having cash reserves anyway.

 

2 - Business Survival During Downturned Economies

As mentioned already in this article, bush fires and pandemics are, sadly, great examples of major events over which we have no control that can cause significant business interruption or even trigger a recession.

Without cash reserves ‘on hand’ it is likely that downsizing the workforce or even declaring bankruptcy become necessary. Armed with cash however, the business may have more options and is better able to weather the storm.

 

3 - Acquisition Ability

At the time of writing this we have another perfect example of how big companies consider the importance of ‘cash’. History has shown us with eBay and PayPal; that was all about cash. As was Disney and Pixar. And the most recent example is LuluLemon purchasing Mirror (a home fitness startup) again demonstrates how a mainstream retailer has embraced a business model that generates regular cash through subscriptions.

 But, without significant reserves of cash, Lulelemon would not have been able to pounce on Mirror (for a cool $500 million USD) and may have missed the opportunity.

 

4 - Lower Transaction Costs

Whilst convenient, electronic transaction systems such as PayPal and Stripe do come at a cost. Sometimes, a premium cost. So in the constant search for reducing operating costs for any business, reducing fees to payment gateways and institutions is a very real benefit - so long as you have the cash to make the payments

 In the same vein, having cash on hand can help avoid late fees or miss ‘prompt payment’ discounts which some suppliers favour as a vehicle to improving their accounts receivables position. Side comment: could you offer this to your customers?

So as you have read. These are just a few examples that help demonstrate that cash is (still) King and, as professional business advisors and certified accountants, we counsel our clients to prioritize its importance.

If you have any questions about your business, we’re here to help. We’ve been serving our clients on the South Coast and in the Southern Highlands of NSW through our offices in Bomaderry and Moss Vale for many years.

As the subject of ‘cash’ has shown in this article, running a successful business requires much more than simple tax compliance. It’s a calculated juggling act of financial expertise and wealth management strategy too.

 

Get in touch for a chat about your business today.

 

If you have any questions about your cash management. We are here to help.
Contact us for professional business and accounting advise.