We often hear that ‘cash is king’ but what does it really mean for a business? Fundamentally, it means that focusing on the cash flows of a business is the best way to manage its operations. It allows the business to use cash to drive growth and avoid cash being tied up unnecessarily where it cannot be used for growth.
Accruals-based accounting does not give us immediate visibility of cash flows. It books revenues and costs at the time they occur rather than when cash changes hands. When you add in other non-cash transactions, such as depreciation, the income statement can start to look very different from the net movement in cash position. A company can book an accounting profit while losing cash in the same period. This can limit management’s ability to spend money on growth-related activities like product development, key hires, advertising, and marketing, as there may not be enough cash in the bank to undertake such expenditures.
The cash trap
We use the term ‘cash trap’ to refer to areas of the business where money is tied up in non-growth-orientated ways. Surprisingly, cash can be unnecessarily tied up in many of these cash traps.
There has been a lot of focus in strategic management circles on the ‘cash conversion cycle’ (or the ‘working capital cycle’). This is where cash is tied up in inventory or is inefficiently utilized through long client payment terms and short supplier payment terms. The net impact of these elements traps cash in working capital, diverting it away from growth-oriented activities.
However, large pools of cash can be inefficiently tied up in a business in other ways. Unnecessary capital expenditure can consume huge amounts of cash. This is why understanding the free cash flow (FCF) of a business is key. FCF takes into consideration cash generated from operating activities as well as cash tied up with working capital and capital expenditures. Increasing the FCF of a business allows it to free up cash to continuously reinvest for growth, distribute to owners, or pay down debts.
Devices-as-a-Service as a free cash flow enabler
Purchasing laptops and phones is a cash trap. Investing large sums of money in these devices ties up cash over the long term—cash that could be better reinvested in growing the business. Device rentals represent the most cash-efficient method to access all the phones and laptops a business needs. This removes large one-off expenditures with their detrimental effect on FCF and instead replaces them with far lower monthly costs. This improves the FCF of a business, ultimately placing more cash in the hands of business owners to do what they do best: deploy for growth.
Implementing a cash flow-centric strategy
To successfully free up cash flow and eliminate cash traps, businesses need a structured approach:
1. Accurately and throroughly assess the current cash flow
Begin by conducting a thorough assessment of your current cash flow. Identify areas where cash is tied up and evaluate whether these investments align with the company’s growth strategy. This assessment should involve a detailed review of financial statements, cash flow forecasts, and liquidity measures. Engage with financial advisors or employ specialized software tools that can provide more detailed insights into your cash flow patterns.
2. Prioritize investments
Focus on investments that directly influence growth. For example, instead of purchasing equipment upfront, consider leasing or renting options that offer the same utility with better cash flow visibility. Rank your investment opportunities based on their potential return on investment (ROI) and cash flow impact. High-ROI projects that also improve cash flow should take precedence. Tools such as Net Present Value (NPV) and Internal Rate of Return (IRR) can assist in identifying the most lucrative opportunities.
3. Optimize the cash conversion cycle
Work on reducing the time cash is tied up in workflows by negotiating better payment terms with both suppliers and customers. Streamlining inventory management can also significantly enhance cash flow. Implement just-in-time inventory systems to reduce excess stock, and use automated billing systems to accelerate accounts receivable collections. Utilizing supply chain financing solutions can also unlock the capital tied up in the supply chain, enhancing overall liquidity.
4. Engage in cash flow-optimizing strategic partnerships
Partnering with companies that offer services and products on a subscription basis, such as devices-as-a-service, can mitigate high initial outflows. This approach also offers scalability, allowing businesses to adjust as their needs change. Moreover, these strategic partnerships often come with added benefits such as streamlined vendor management, reduced administrative burdens, and access to dedicated support services. It’s also wise to negotiate flexible contract terms that allow for scalability based on evolving business needs.
The overall benefits
Employing a cash flow-centric strategy has far-reaching benefits beyond just freeing up cash. It can facilitate better financial planning and more agile decision-making. Enhanced FCF can also improve a company’s valuation and attractiveness to investors. Additionally, keeping cash flows positive helps in maintaining operational stability, reducing the necessity for external financing and thereby minimizing interest-related expenses.
Conclusion
In summary, the mantra ‘cash is king’ emphasizes the significance of liquidity for driving business growth. Accrual accounting, though standard, can obscure the real cash situation of a company. By focusing on free cash flow and avoiding cash traps, firms can enhance their financial agility and growth potential. Leveraging models like devices-as-a-service further complements this strategy, enabling businesses to stay lean, efficient, and growth-focused.
