Reasons why Cash is King for Business
Updated: Jun 6
The origin of the expression “cash is king” is not clear but it’s a phrase often used during global financial crisis such as the global stock market crash of 1988, the subprime mortgage crisis of 2008 and now the coronavirus pandemic of 2020 which has delivered the fastest, deepest shock to the global economy in history.
A company may have all the revenue in the world, but without the ability to generate cash, it can easily fail; and in times of crisis, holding cash gives business owners and investors more options, and in times of economic uncertainty having this flexibility is crucial.
Here are some other advantages that strong cash flow management brings.
Scaling your business
Your growth plan may call for hiring staff and attracting top talent, developing and deploying new technology, adding equipment and facilities and creating systems to measure and manage results. The ability to realise and release more cash in your business is essential to accelerating growth.
Company Acquisition to Fast Track Growth
One strategy for companies to fast track expansion is to acquire other companies, either within their niche or as a way to branch out into new geographies, customer networks or complimentary products and services.
In acquisitions, buyers usually pay the seller with cold, hard cash. Without the necessary cash, these companies would never have been able to jump on the once-in-a-lifetime opportunity to buy a valuable company. For example, when Microsoft and Salesforce were offering competing bids to acquire LinkedIn in 2016, both contemplated funding a portion of the deal with stock. LinkedIn ultimately negotiated an all-cash deal with Microsoft in June 2016.
Positive Cash Flow
For your company to survive, cash flow is the single most important financial factor.
Of course, if a business has just been launched, it may be able to endure negative cash flow in the short-term in hopes of achieving long-term success. But eventually, any company must focus on creating positive cash flow. Without it, a company will not even be able to accomplish the simplest of tasks: paying its monthly expenses.
Capital Expenditure (CapEx) Investments
To grow, a company often will need to acquire, upgrade and maintain physical assets such as property, buildings, industrial plant, technology or equipment. These are typically one-time costs that require significant funds. Without cash on hand, your business may not be able to make these necessary investments and, as a result, may never be able to experience company growth.
Sure, your business can take out a loan, but even a loan will generally require a significant down payment, which will in turn require that your company have access to cash. Loans also come with interest rates that can further eat into your company’s bottom line.
Investor Dividends and Share Repurchase
In today’s record low interest rate environment, dividend paying stocks have played an important role in attracting investors. A company’s willingness and ability to pay steady dividends over time, and its power to increase them, provide positive cues about a company’s management of the fundamentals. As dividends are a form of cash flow to the investor, they are an important reflection of a company’s value.
A share repurchase, or buyback, can boost the value of the stock and improve the financial statements of a company. Companies tend to repurchase shares when they have cash on hand
Survival During an Economic Downturn
Running or managing your business often leaves little time to keep track of national, and even regional, economic indicators that might affect your industry and your specific operation. Yet conditions such as interest rates, inflation, gross national product, stock prices and consumer confidence have direct impact on your profitability and on your relationships with vendors, customers and even employees.
Firms who maintain a strong cash stream during a downturn are typically more innovative and able to flex to market changes, and this works to their advantage. They can gain market share by taking it away from competitors unable to adjust to shifting market conditions. They can also become leaner, more cost-effective, more operationally efficient and better positioned to do well when the market improves.
Preparing for Emergencies
Various hazards and threats such as extreme weather and cybercrime could have a big impact on your business, not only directly but also on the services your business relies on such as transport, utilities, communications and financial services.
Being more prepared and resilient can protect your business and give a competitive advantage to your business. The actions you take to make your business resilient will depend on your circumstances and the risks you are comfortable taking. Having assessed these, you need to decide how much time and money you want to invest in increasing your resilience, and how much cash reserves you may need to pay expenses right away to keep the lights on in your business.
Improve Exit Options
As you prepare to transition out of your business using any type of ownership transfer model, whether to insiders (children, employees, co-owners) or outside acquirers, it is imperative that you secure an accurate future cash flow model.
There are many factors that affect the valuation and overall marketability of your company but typically the single most important factor in the overall value of your business is a multiple of your net cash flow.
For example, if your net cash flow is £500,000 and your company is the market leader, has consistent traffic and revenue, has a good infrastructure and organisation that is self-sustaining without your skills or leadership, you may have a multiple of seven times your cash flow – a valuation of £3,500,000.
Conversely, if your revenue is declining, most of the business knowledge is in your head, and you are running the business on old infrastructure, your multiple may only be 1.5 times cash flow, or £750,000.
The most successful exit strategies are the ones that are planned years in advance, invest effort into improving the key factors and increasing net cash flow.
Cash is King
Make sure you prioritise the importance of cash. Its availability is essential to not only avoid the possibility of bankruptcy, but also to take advantage of various expansion and growth opportunities.
READ NEXT: How to maximise cash in your business
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Selina Bolton is a business strategist and the founder of Seed.Partners; a mergers & acquisitions firm specialising in attracting investment and creating opportunities for small to medium-sized businesses to scale and build value at pace.
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