Cash Flow: Numbers Don’t Lie, But Sometimes They Need Context

Cash flow is an important metric for determining the health of your business. However, as discussed in the previous post, it is not as simple as looking at a single number without context.

There are many factors at play in determining whether this number is really an indicator of a successful business or not. One factor, not previously mentioned, is how the cash flow total, whether positive or negative, compares with the overall bank balance in the context of the # of Month’s Expenses that are in the bank.

Cash flow is only important when compared to the bank account.

For instance:

Despite the significant cash flow for January, this company is in a cash flow crunch. If all revenue were to stop for just two weeks (half the month), Company A would be out of cash to cover expenses for the month requiring the immediate sale of assets, laying off employees, an owner investment, or a new line of credit to cover those expenses.

On the other hand:

While it is not a good long-term trend, Company B is in a better position to handle the negative cash flow, even if it was sustained for a season. The reason behind this is that, if all revenue were to stop, the company would remain viable for 7 months.

Businesses Run on Cash

Again, the ideal situation is consistent positive cash flow that leads to an increase in liquid assets as well as wealth-building. But there are instances, such as businesses built on seasonal sales or services, in which the need to build liquid assets exists because negative cash flows are an expected part of the business’s life cycle.

While looking at cash flow in the context of what drives the flow and the individual goals of the business owner, the number must also be put in the context of the total liquid assets in the bank. The long-term sustainability of any business requires liquid assets to cover the cost of running the business. It is generally recommended that a business has between 3 and 6 months of expenses liquid in the bank account. In the case of seasonal business, it is often recommended that that number be higher to balance the months of anticipated negative cash flow during down seasons.