Understanding how your business generates cash

As we start adjusting to the new realities of business post Covid-19, I thought this would be a good time to review how businesses usually generates and utilises cash during the course of the year.  When I do workshop with clients, I often ask the question “How many of you have at one point had a great profit year only to be told by your accountant or banker that you are in a worst cash position than last year?”.  The hands usually reluctantly go up and I introduce them to the Statement of Cash Flow from their financial statement.  For a lot of entrepreneurs, this is the first time they look at this statement and they don’t fully appreciate its importance nor its wealth of information.  Let us dig in a bit more.

1. Cash from operations: In this first part of the statement, we have a look at how your business generates cash from the operations.  This includes net profits, depreciation and amortisation.  This is probably one of the areas that we have a lot of control over.  Every entrepreneur wants to run a profitable operation and in looking at this section, we knowif we are or not.  But it doesn’t stop there.  Have our profits been growing over the past few years or are we in decline or stale.  As entrepreneurs, we often get caught up in overall revenues without giving enough thoughts on if profits are keeping pace.
2. Non-cash working capital: In this section, we start examining how our cash can get tied up in non-cash working capital items.  Because we are profitable, we may start to extend more credit to our clients while deciding to pay our suppliers faster.  This can create a double hit on cash flow.  Another area to focus also is in the growth of your inventory.  Without proper management, inventory growth can take on a life of its own and I have often seen companies with a large portion of their retained earnings tied up in inventories that may or may not still be sellable.  It is not uncommon for us to see companies using 80%-120% of the cash generated in their inventory and accounts receivable.
3. Investing: In this third section, we look at how the company is using cash to invest in long term assets.  In taking with our “Cash is King” motto, we always want to make sure that investments in long term assets are matched with proper long term financing in other to benefit from leveraging and maintaining a positive cash fow by not using working capital funds to finance these assets.
4. Financing: Finally in this section, we see the cash that has been utilized for paying down our long term debts (current portion).  We also see if any new long term debts we obtained to finance the financing activities from above.  Typically in this section, we will also see if our operating line of credit has increased or decreased over the past year.  This is the final indication on whether or not we are managing cash properly.

I hope this helps you understand how cash flows through your company.  When we complete the NuFocus Cash Flow Builder with our clients, they are often surprised how we are able to sqeeze out cash from each of these sections in order to bolster their working capital postion. Cash flow is the lifeblood of any business and now more than ever, owners need to be conscious on how it is created and how it is being utilized. For more information, please contact Richard at r.theriault@nufocusgroup.com