Why cash flow is important

Cash flow simply means the money which moves through your business or personal accounts. It’s better to have more cash coming in than going out. When this happens, one is able to meet their immediate cash obligations and service any debts. When the reverse happens things get tight. When you spend more than you earn, you eventually end up in debt. If things don’t improve you may have to sell off your hard-earned assets to repay your debts. This can be quite stressful if not properly managed.

Different ventures have different cash flow patterns. Some businesses require a huge capital expenditure at the start and then the money trickles in over several years. This typically applies to rental properties where you spend millions at the beginning and earn rents over decades. Some ventures require a huge upfront expense and the cash is recovered in a lump sum at some point down the road. For example, if you buy land today and sell it several years down the road. Some businesses have low capital requirements and the cash is recovered on a daily basis. This applies to many small informal trades like roadside vending and the like. Knowing the cash flow patterns of a potential business can save you a lot of heartache down the road. For example, if you need a daily income you should not grow a forest. You would rather open up a small shop selling foodstuffs.

Cash flows are by nature difficult to predict and many things affect them. For example, things like seasonality of demand, inflation, pandemics, natural disasters, government policy, etc. can affect your cash flows. For example, the current fuel crisis in the country has driven up prices which is going to affect people’s cash flows. 

Since cash flows are variable we need to create buffers to protect us when cash flows decline. The main idea is to save up and invest as much as you can when things are going well so you can go through the dry spells. An emergency fund comes in handy to smoothen the curve when cash is running low. We also need to do as much as we can to improve the demand for our services and products. This can be done by aggressive marketing and improving the quality of what we have to offer. For example, you can attract a higher salary if you improve your skills and market your potential on LinkedIn. We also need to spend prudently especially when things are going well. This gives us some room to save for uncertain times.

Prudent management of short-term assets and liabilities is essential to improve cash flows. Customer credit should be limited and collected as fast as possible. We can also increase pricing to improve margins. Inventory should be kept to a minimum to preserve cash. Cash balances to cover three to six months of expenses should be maintained. Payables should be delayed as much as possible without hurting relationships. Debts should be minimized and paid on time to reduce interest costs. Ideally, you want your short-term assets to be twice as much as your short-term liabilities. This way you will be able to meet your immediate obligations without too much hustle.

Cash flow is the bloodline of any economic system. You don’t want to be asset-rich but cash-poor. It is therefore important for all of us to prudently manage our cash flows so as to have a bit of peace in our financial lives.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s