Cash is more important than profits

I always tell clients: cash is more important than profits.

Just imagine, you are on a desert island without water or food. A genie appears and offers to save your life. He offers you bread and water today and for as long as you are on the island or a three month wait in order to be eligible to drink and eat anything you want. As attractive as the second option is, given its infinite possibilities, I think most of you would sensibly take the bread and water so as to make sure you at least live. I mean what good is the second option if you die in the process of waiting for it.

It is the same for a business when dealing with cash or working capital yet it doesn’t get the attention it merits.

The hard fact is that a business is better off with a steady cash flow and smaller profits than an irregular cash flow and (eventual) larger profits. Cash is today, profits are tomorrow and the timing of your cash inflows and outflows is everything in business.

Linked to this point, I recently read an article in the respectable English publication Management Today, which stated that 50%+ of UK small businesses (by small they mean: employing less than 50 employees) could run out of cash in two weeks. So a temporary closure of the business caused by say a flood or a freak storm (not so unusual now-a-days) could put a going concern out of business.

According to this same research, a total of 52% of small businesses have cash reserves of less than £10,000, while 20% have none at all. I find this most interesting and I am quite sure that the same in-built weakness applies to Maltese businesses. From my experience, there are far too many local businesses struggling to keep up with their trade payables and trade receivables due to inadequate working capital and (even worse) an all too large number of businesses with a large part of their overdraft in 'perma-freeze'.

The truth is that businesses are so hell bent on trying to maximise their profits, increase sales revenue or expand (to mention just a few) that they very often neglect what keeps their very business alive: cash.

Cash is any businesses’ life-blood. It is, therefore, fundamental that you keep a close eye on it. I am here referring to the sound management of working capital and the practice of setting performance targets for working capital and free cash flow.  

Don’t get me wrong. The purpose of any business is not to hoard cash, which, incidentally, is almost as poor a practice as inadequate working capital and something our recent forefathers used to do but we seem to have gone to the other extreme. What I am referring to is the practice of reducing your business's cash flow cycle (the time it takes to turn assets and liabilities into cash), the management of optimal inventory levels, swapping capital expenditure on plant and machinery with leasing, negotiating better supplier credit terms and incentivizing your clients to pay upfront or within agreed (shorter) credit terms.

In other words, the objective isn’t to hoard cash but to be efficient in its use and to improve your cash position so as to be able to fund value-creating opportunities that come your way from time to time and this brings me to my final point.

Don’t look at cash management as simply an exercise not to run out of cash. Treat cash management, also, as a positive, forward-looking, exercise, which allows your company to pounce on an opportunity with lightening speed when it presents itself. Normally, great business opportunities come unannounced and for a short-time only so if you don't have the cash to grab it (i.e. you have to ask your bank or shareholders all the time) you will most likely lose a lot of business opportunities.  

At the beginning of this article, I intentionally quoted a ridiculous scenario on a desert island in order to emphasize a point. I am not in the slightest recommending that your business lives on the metaphorical bread and water. My point simply is that cash is the lifeblood of any business and without it you can have all the future profits you like since you'll still go bust. It is for this reason that I think cash is more important than profits.

In the words of Warren Buffet: 'We always keep enough cash around so I feel very comfortable and don’t worry about sleeping at night. But it’s not because I like cash as an investment. Cash is a bad investment over time. But you always want to have enough so that nobody else can determine your future essentially.'