The Importance of Cash Flow for Business at Its Various Stages

By Published On: 01/11/2023Актуализирана: 01/11/2023
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Cash flow is an extremely important aspect for every business, whether it’s a startup, a growing business, or a mature business. It represents the movement of money into and out of a business and plays a crucial role in financial health and resilience against external and internal influences. Simply put, cash flow is the actual money you receive and actually spend at certain times, regardless of the claims and obligations you have at these times. Cash flow and revenue are different concepts, and often in practice, business owners don’t make the correct distinction between them. Having revenues doesn’t necessarily mean you’ll have cash, and conversely, it’s possible to have cash (due to other factors) but have no revenues. The relationship between cash flow and revenue stems from the business model, the economic environment, and the position of the specific business within that environment, both now and in the coming years.

The role and importance of cash flow can vary depending on the phase of business development:

Startup Business

Assessment of Financial Stability

For a startup, cash flow is essential as businesses often start with limited resources and need sufficient cash to cover their expenses and invest in growth. A cash flow shortage can lead to serious issues, limiting growth opportunities, and even leading to bankruptcy.

Growth is a primary goal for any professional business. Ensuring growth is crucial as maintaining a company’s status quo is only possible for a very short span. This means you’re either going up or down, whether you like it or not. Hence, it’s better to aim upwards. However, it’s important to note that growth might not always be the best decision depending on certain economic conditions. So, the balance between pushing for growth and maintaining financial stability often depends on the economic outlook in your operating environment.

Attracting Investors
Cash flow is a key indicator that attracts investors and creditors. Investors usually scrutinize the cash flow history of startups to assess the risk and potential return on their investments. Creditors do the same, aiming to ensure that the likelihood of getting their money back with interest is substantial or close to 100% certain.

Managing Liquidity
In the early phases, when revenues might be sporadic or limited, managing liquidity (the ability to meet current obligations) is paramount. Cash flow helps startups plan and manage their finances. In this phase, expenses could either be more restricted or, conversely, the most significant chunk of all expenses. Based on this factor, a liquidity strategy is devised.

Growing Business

Financing Growth

Cash flow provides the resources necessary for financing the expansion of the business. This growth can include expanding production capacities, opening new sales locations, developing new products or services, hiring additional staff, and more. To ensure resources for these investments, the company must have a sufficiently positive cash flow. This might stem from client payments, creditor money, investor funds, or a combination of all.

Managing Liquidity

A growing business might experience increased pressure on liquidity, as expenses and investments might rise due to a delayed effect on revenues. Typically, after making an investment, returns come with a certain delay, and this should be anticipated. Cash flow helps identify and manage this pressure, ensuring adequate funds to pay off current liabilities in a way that’s most beneficial for the company in the long run.

Attracting Investments

Businesses in growth often seek external investments or financing to fund their projects. Investors and creditors use cash flow information to assess the financial health of the company and the potential risks and returns on their investment. A positive cash flow from actual clients can increase the likelihood of successfully attracting investors or securing loans, i.e., the probability of additional cash inflow.

Evaluating the Effectiveness of Growth Strategies

Cash flow allows the business to track the results of various growth strategies. Analyzing the cash flow can help managers determine which projects or activities are most profitable, how to direct resources for maximum growth and profit in specific activities, what the best ratio for allocating funds is for generating the highest cash flow, and evaluating the sustainability of the business over time. Not always is the most profitable activity in the short term beneficial in the long term.

Creating Shareholder Value

For publicly traded companies, growth and cash flow directly reflect in the stock value. A positive cash flow, especially when it’s consistent and growing, can contribute to increasing the stock value, ensuring liquidity of the stocks, and increasing shareholder satisfaction.

Mature Business:

Generating Revenue and Profit

For a mature business, the primary goal is often to generate steady revenue and profit. Overall cash flow remains essential, but the presence of consistent and growing revenue can contribute to a better overall financial situation.

Investments in Growth and Finding Balance

Mature businesses often use their cash flow for investments in expanding their operations, developing new products or services, acquiring competitors, and other strategic initiatives. Deciding how much of the funds will be invested in new products and how much will go to investors is a strategic decision.

Investments in Transformation

Investing in business transformation can be exceptionally important, and depending on the specific situation, it might be essential for the long-term success of the company. It’s important to note that every business is unique, and the significance and inevitability of investments in transformation can vary depending on various factors, including industry, competitive environment, the state of the business, and strategic objectives.

Paying Dividends

Mature businesses might distribute dividends to shareholders, thereby fulfilling their initial promise to them, which is the return on investment.

In summary, cash flow is vital for any business, and it can have different emphases depending on the company’s stage of development. For a startup business, it’s essential for evaluating financial stability and attracting investments; for a growing business, it defines liquidity management and growth opportunities; for a mature business, it’s tied to tasks like investments, balancing between satisfying investors and new growth, analyzing the needs for transformation, and ensuring the funds for it.

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