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M
any equate the success of a company to its
reported prots. While prots are good, they
do no adequately represent the nancial
standing of a rm. It is quite possible for a company
to report prots but go out of business. It is also pos-
sible for a company to be protable and not be able to
grow, secure nancing, or attract investors. There are a
couple of reasons why cash ows are a better indicator
of a company’s nancial health.
Cash is King
Prot gures are easier to manipulate because they
include non-cash line items such as depreciation ex-
penses or goodwill write-offs. Under generally accepted
accounting principles (GAAP) businesses can use non-
cash expenses such as depreciation and amortization
to offset large capital expenditures.
Cash ow statements, on the other hand, provide
a more straightforward report of the cash available.
In other words, a company can appear protable “on
paper” but not have enough actual cash to replenish its
inventory or pay its immediate operating expenses such
as lease and utilities.
If a company cannot purchase new inventory, it will
slowly become unable to generate new sales. If a
company cannot afford its operating expenses, it will
eventually go out of commission. Either way, “Cash is
King” in keeping a business alive.
Cover the gap between
receivables and payables
Another important consideration is that prot reports
are based on sales income. The main issue here is that
the recorded revenue is often greater than the amount
of actual cash received from sales. When sales are on
credit, the collection period on
accounts receivable can last 2-3
months. This means that the
company needs to have enough
cash on hand to oat its opera-
tions for the duration of the col-
lection period.
Using the previous examples,
this means having the cash equivalent of 2-3 months’
worth of operating expenses and inventory purchases
on hand. In the likely event that a rm also makes
purchases on credit, accounts payable become another
important factor to consider. To be sustainable, a busi-
ness has to pay special attention to its cash cycle and
make sure to cover the cash gap between receivables
and payables.
Why cash ow is more important than prot
It is quite possible for a company to report prots but go out of business. It is also possible for a
company to be protable and not be able to grow, secure nancing or attract investors.
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If the business goes out of cash, operations will sim-
ply cease. This further illustrates why cash ows provide
a better sense of the nancial situation of a business.
Why lenders look at cash ow
Assuming that a rm has enough cash to maintain
its current level of op-
eration, most business
owners want to grow their
company. If cash is king
in sustaining ongoing
business operations, it
becomes that much more
vital when considering
expansion. Sales growth
is great… unless it results
in the total depletion of
cash. Companies should
prepare for cash outlays to considerably exceed cash
inows during the early stages of expansion. In fact, to
be able to generate a growth in sales, businesses must
rst be able to afford an expansion in capacity. This
Companies should
prepare for cash
outlays to considerably
exceed cash inows
during the early stages
of expansion.
SOURCES
Fulmer, J. G., Jr., Finch, J. H., Smythe, T. I., Jr., & Payne, T. H. (2002). Growing sales and losing cash: Assisng your small-business cus-
tomer with cash ow management. Commercial Lending Review, 17(4), 14-19.
Glassman, J. K. (2012). Go With the Cash Flow. Kiplinger’s Personal Finance, 66(8), 16-18.
Osgood, W. R. (2004). Common Sense Cash Flow Management. Strategic Management Learning System Workbook 1. Knowledge
Instute, Inc.
increased capacity can come in the form of additional
personnel, equipment, new locations, more inventory,
etc. Either way, the company has to be able to remain in
operation until its cash ows stabilize and become posi-
tive.
Business owners may think that securing commercial
nancing will solve the growth dilemma. It is not that sim-
ple. Lenders expect regular repayments on the nanc-
ing they provide. As such, lenders rely on a company’s
current and projected cash ows to determine whether it
will be able to afford the additional debt.
Overall, understanding a company’s cash situation
is crucial to making sound business decisions. Owners
must strive to understand and always be in-touch with
the cash aspect of their enterprise, regardless of the
prots reported. Fortunately, business owners do not
have to do it alone. They can work with their bookkeeper
or accountant to review how cash circulates through
their business. They can also take advantage of the
Small Business Development Centers available to small
businesses and aspiring entrepreneurs throughout the
United States and its territories.
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About the author
Aretha Boex is the Omaha center director of the
Nebraska Business Development Center. She man-
ages the small business consulting program and leads
a team of professionals who provide direct technical
assistance to owners and potential owners of small
businesses. She brings extensive experience in man-
agement consulting, business planning, nancial analy-
sis and small business loan applications. Aretha is a
Certied Economic Development Finance Professional
through the National Development Council. She holds
a Master of Business Administration and a Master of
Science in Management Information Systems from the
University of Nebraska at Omaha.
About the Nebraska Business Development Center
NBDC is a cooperative program of the U.S. Small Business Administration (SBA)
and the College of Business Administration at the University of Nebraska at Omaha
(UNO). NBDC partners with the University of Nebraska at Kearney, Southeast Com-
munity College, Wayne State College, Mid-Plains Community College and Chadron
State College to provide consulting and business support services from ofces in
Omaha, Lincoln, Kearney, Grand Island, North Platte, Wayne, Auburn, Scottsbluff
and Chadron. Learn more about NBDC at nbdc.unomaha.edu
© 2015 Nebraska Business Development Center
Permission is given for reproduction of this whitepaper in whole or in part, provided that the
copyright notice is preserved and that the author and the Nebraska Business Development
Center are acknowledged
