RANDBURG - Chief Executive Officer of credit-management specialist, Debtsource, Frank Knight tells of why profitable businesses still fail.
With regard to business accounts, profit and cash-flow are key financial measurements.
However, the two are not directly linked, neither are they equal measures of success.
Profit is a measurement of a company’s sustainability on an ongoing basis, while cash-flow is a measure of a company’s ability to pay its bills in due time.
A company is vulnerable to collapse when there is a lack of cash resources.
Cash is the crux of a business.
A business needs to generate sufficient cash from its activities in order to meet operational expenses, for instance, repay investors or grow the business.
“The truth is a sale is not a sale until it has been paid. Turnover is just vanity,” says Frank Knight, CEO of credit management service, Debtsource.
With three out of every five companies in South Africa failing whilst showing a profit, Knight explains the collapse.
Profit margins
On paper, your business may reflect as profitable yet you still find yourself facing a cash flow crisis.
Despite your income statement reflecting that you have made a profit, this does not necessarily mean that you will have the money in your bank account.
Cash flow is thus more fluid as it changes depending on environment and may vary from month to month.
Pre-emptive management
Small businesses and start-ups often face financial problems when correct cash flow strategies are not implemented from inception.
Business may be overwhelmed with 'getting a deal' and subsequently, they disregard whether the customer can or will pay.
Yet, the former is the most important questions to ask, especially so for start-ups.
Wages and salaries, rent and rates, raw materials and components, hire purchase repayments – all of these must be paid out of monies received from paying customers.
Selective debtors
If your clients utilise mainly credit, it is paramount that you assess their credit history.
It can be detrimental to your company to rush through a process, especially if the client does not pay on time.
Planning ahead
Businesses cannot predict the future, yet it can examine historical trends in order to protect its cash flow.
Seasonal fluctuations and the cost of marketing campaigns should all be factored in when planning ahead.
This will create a more accurate indicator of stability and risk of failure, says Knight.
Cash (flow) is King
The fundamental point is that cash flow will always be king.
Business-to-business sales are particularly vulnerable as they rely primarily on later payments, hence they run the risk of delayed payments long after the product or service has been processed.
Profit is not consonant of cash flow.
It is crucial for a company to secure their cash income, prior to spending money.
"Never underestimate the absolute importance of cash flow to the health of a business.
It is a key indicator of financial health, underpins stability and can give better buying power,” Knight concludes.