The term cash flow is King is one used quite often in the investment world. To all intents and purposes a business with negative cash flow will eventually run out of funding no matter what the level of “paper profits”. Just recently it was announced that Tesla “should be” cash flow positive in each quarter from here on in. This is a massive about turn for the company after a very troubled period in its history.
Is all good and well buying assets today which could make you three or four times your investment in five years. The problem here is that your funds will be tied up for the next five years and you may have insufficient cash flow to cover your expenses/loan repayments. In essence, the potential future returns for your company may seem very attractive what happens when you run out of cash?
Growth is an area where company funds can be used to create a significant long-term return. An investment today in computer systems, sales staff, etc would likely create an immediate return and greater efficiencies. The same type of investment in a new warehouse or new office could end up absorbing the majority of your funds on deposit and hitting your cash flow.
Finding a balance
Whether you own a company or you are a director/shareholder, there is a need to find a balance between debt, investment returns and cash flow. It is imperative that short-term cash flow is protected to ensure there is no shortfall to cover liabilities. History shows is that the more successful companies in the world do not live in a short-term world. Very often they can invest significant funds today which may not reap any significant rewards for a number of years. However, there needs to be a balance.
We have all seen some of the best-known companies in the world struggling financially at which point the vultures begin to hover. Short-term cash flow difficulties may see them selling some of their prized assets in a fire sale. Traditionally this would mean selling the assets at a discount to bring cash into the business as quickly as possible to allay short-term cash flow fears. If those fears were not addressed then the bank may call in loans and the company could go into administration/liquidation. At this point, the fire sale of all fire sales would likely begin!
Any responsible business will be open to short, medium and long-term investments where the risk/reward ratio is perceived to be in their favour. Sometimes these “too good to be true” deals turn out to be just that. It is imperative that all companies maintain a level of financial headroom which means surplus cash to cover their liabilities in the event of unforeseen problems. There is no point living on the limit of your financial resources because one day you will experience a drop in sales, system failure or a similar situation. This could quite literally bring the house down!
Paper profits tend to grab the headlines but cash flow is and always will be King. It is all good and well having funds invested on a “jam tomorrow” basis but your liabilities need to be covered today. No company is bombproof, no business is ever 100% safe and profit margins will tend to fluctuate over the years. Maintaining a level of financial headroom ensures you can give yourself some time to tackle unforeseen issues in the future. Keeping one eye on the short-term, medium-term and long-term potential for your business is not easy. Maintaining cash flow is certainly a good start.