Business Acumen 101 – Cash is King
In the world of Business Acumen or how money is made – Cash is King. In fact, the generation of cash is the most critical element for organizations. Every small business knows this and in this economic downturn some of the largest companies in the country are learning this lesson – the hard way.
Okay, it’s time for another term definition:
” Cash Generation – the difference between the inflow of cash and the outflow of cash.”
As you can imagine after reading the definition that you can positive or negative cash flow. This becomes the focus of determining cash is King. A negative cash flow can deplete cash reserves and create a myriad of problems for any organization. A positive cash flow can build your cash reserves – which provide options to management to gain advantages in the marketplace.
What are the problems that can happen with negative cash flow?First, a company can actually run out of cash which makes it very difficult to remain in business. If you cannot pay your bills and your employees, you are out of business! This is usually the last straw before a bankruptcy is filed.
Second, a company with limited cash cannot take advantage of early payment discounts or volume purchase discounts. This will increase their cost of doing business and lower both their competitive position and their profitability. Basically, the lack of cash eliminates the choices or flexibility that management needs to take advantages of opportunities or to gain a competitive advantage.
Third, a company has to watch its minimum cash level due to provisions in lending agreements. Financial lenders usually place a minimum cash position on a company, which becomes a trigger for “calling their loans.” Calling a loan usually has a very negative effect on a company. It puts pressure on the company to cut expenses and build its cash reserves, miss on opportunities due to a freeze on certain types of spending and decisions are made to conserve cash rather than grow the company.
Fourth, if a loan provision – such as minimum cash level – is violated and a loan is called can create an even bigger cash flow problem. The lending organization may freeze their deposits to “offset” the loans or the lending organization will place all the account receivables in a “lockbox” relationship into default. When this happens all the payments made to the company are applied to their loans rather than placed in the company’checking account for normal operations. Again, this is usually a first step to filing for bankruptcy protection.
Finally, negative cash flow creates major stress on the managers and executives of an organization. When this happens little attention is focused upon strategic thought. Therefore, critical decisions are put off to a later date. This can lead to missing a business opportunity window – becoming the last player into an opportunity means little to overall results.
Thursday, we will talk about the impact of positive cash flows on cash generation and what that means to an organization.