Cash flow is often seen as one of the major financial indicators for the health of a business, because it impacts such a significant amount of the business. Success, in fact, is often predicated on good cash flow. However, it’s not always unprofitable businesses that can face troubles.
How can a business be profitable but with poor cash flow?
On the face of it, it would seem that a profitable business must have good cash flow. If income is comfortably higher than outgoings, then surely there is cash in the bank? Unfortunately, this is often not the case. The main cause of this is of course late- and non-paying customers.
It’s very common for companies to have problems whereby they’re doing lots of business, but when it comes to actually getting the money, they run into difficulties. 30-day payment terms are the standard, but it’s often the case that this can stretch to 60- or even 90-day terms, which can have a major impact on the availability of cash. At any given time, millions of pounds are outstanding and owed to UK SMEs. Certain industries are more susceptible than others. There are a couple of major factors:
1. Low volume, high value orders
The first is businesses that generally operate low volume, high value orders. This model means that very large amounts of money can be outstanding at any given time. Just a couple of late payers can mean big sums of money missing from your account. This can be devastating, particularly for smaller businesses that have monthly commitments that they need to cover.
2. Long chain of people to pay
The other issue is industries where late payments are very common, or where there’s a long chain of people to pay. Construction is a good example; subcontractors at the bottom of the pecking order often have to wait for money to trickle down to them, which means they can be waiting a long time. They’re also at risk of contract disputes that can hugely lengthen the time it takes for finances to be settled.
What happens if cash flow is poor?
In a best case scenario, poor cash flow simply prevents a business from being able to invest and grow. However, in a worst case scenario, really poor cash flow can put an otherwise successful enterprise out of business. The importance of cash flow cannot be understated. If we go back to the construction industry for example - a subcontractor that wins and carries out their end of a contract may suddenly find that the money doesn’t get paid, whether because of a dispute or a link in the chain going out of business. This can mean that they cannot pay wages or other expenses, and there is the risk of collapse. Invoice Finance, and certain types of insurance, are popular as a result. These products try to combat the risks of invoices being paid late or not at all.