Cash Flow: The Lifeblood of a Business, Part 1

L. Douglas Mault

February 2007

There is a tendency for most business owners to look upon cash flow as a complex topic best left to their accountants or bankers, or just ignored until it is too late. Too often cash flow is presented as an arcane topic, the understanding of which is beyond mere mortals.

Well, tain’t so. The diagram below presents cash flow in its simplest form. Granted, it does not take into account certain items such as depreciation and deferred taxes, and it groups items that your CPA would deal with more precisely, but for our purposes, it is adequate.

Given that cash on hand is a requisite for starting any business, let’s examine the diagram and understand its component parts.

Cash is necessary and is used to manufacture and process products, or in the case of a contractor, distribution or dealer, to purchase them. It is expended on items such as raw materials, ingredients, labor, fuel, electricity, equipment repair and maintenance, plant and/or company overhead and other items in Sales, General & Administration expense categories. These are summed up as cost.

This leg of the diagram is as important as the next two. Certainly, especially in today’s aware marketplace, one is expected to supply quality products, manufactured, processed and sold by professionals. Our own expectations as consumers are heightened, and we must be aware that our customers’ expectations of us are heightened as well.

The finished goods, or purchased products, are now put into Inventory. As you can see, the creation of the inventory consumes cash. Many business people don’t pay this much heed unless they’ve borrowed to finance the inventory. The required payments serve to focus their attention. When the inventory is financed out of cash on hand, the fact that there is an interest opportunity lost is too often overlooked; for example, those funds could be invested and earning interest or rolled back into the business to finance things such as marketing, advertising, new products, acquisitions, capital expenditures, etc.

The cash flow associated with products in inventory comes to an immediate halt. Inventory management, that is, maintaining accurate records, protecting the products from weather, damage, theft, aging and physically staging the inventory for ease of storage and shipment, is another critical phase too often ignored or given short shrift.

This cessation of cash flow is the imperative for turning the inventory as rapidly as possible given the constraints of the marketplace.

Disposition of stale, aged, damaged, obsolete or odd-lot inventory is important, but a detailed program for this is outside the scope of this article. Suffice it to say, that disposition of it can generate needed cash.

We will pick up with inventory in next month’s article.

About the Author
L. Douglas Mault is president of the Executive Advisory Institute, Yakima, Wash. Contact him at (888) 858.4324 or eai@ewa.net.