The importance of cash flow

You may have heard the saying, ‘Turnover is vanity and cash flow is sanity’—but what exactly does this mean?

I used to hear, on a regular basis, businesses bragging about how they’d increased their turnover and how well their business was performing—but in reality, how well was the business actually doing and how profitable was it?

A business may double its turnover, but they may be making less profit. It’s important to know these figures and what they constitute.

For example, a business may have decided to diversify and supply wholesale, rather than retail. This would usually have a knock-on effect in that their business’s turnover increases. Does this naturally mean their profits will have increased, too?

Not necessarily. Typically, their profit margins will be lower.

What do we mean by this?

In this scenario, the cost to the business to provide the item or service will have remained the same but they will likely be selling it at a discount to the wholesaler, in return for larger orders. This is where some businesses become busy fools and end up working for nothing.

Something else to note is that, if you supply to wholesale, they will expect a period of grace before they pay for the goods. This could be 30, 60 or even 90 days after they’ve received them. The providing business still has to bear the cost of supplying the goods before they’re paid, which ties up cash within the business.

I have seen many businesses come unstuck because they simply ran out of cash.

So, the next time you get excited about that big wholesale order, stop and think: how will this affect my cashflow, and can my business really afford to do it?