Most will understand the importance of cashflow in business. But often without realising, businesses can build a cash gap. This is the time between when a business pays cash out and makes purchases, to the date the cash is received in from customers and debtors.
It’s important for small businesses to recognise the potential impact this could have on business. For this we need to understand the true important of cash flow. Business owners and leaders don’t want to arrive in a situation where they need to cover the difference, through factoring or bank financing.
To understand the power of cash flow and its impact on business growth, Ray Moore explains ‘The Growth Triangle.’
At its most basic, the model presents the idea that business growth produces more profits for the business, which gives a healthy cash flow which can be reinvested in growth.
But is this really the case?
The second part of the model shows other areas that influence the Growth Triangle. In a more realistic light, profits in the business can become caught up in the balance sheet before creating cash flow. This could be because we’ve given extended credit or we haven’t chased up our debtors for payment.
So what started as profit doesn’t come out of the balance sheet as cash, which restricts how much we can put back into growth.
We may then use the cash flow we’ve got to purchase new machinery or vehicles, so there is even less cash to push into business growth. However, the amount we do invest into business growth then starts to produce more costs in the form of overheads, therefore it doesn’t produce the same amount of profit as before.
This is why business owners often say they made more profit when they were a smaller size and why many business owners settle on their business being a smaller size.
Preparing for business growth
As important step in preparing for business growth is to ‘Set out the Stall' and look at each of the filters in the Growth Triangle so that growth doesn’t drag in more cash, without making a profit. Ensure that your return on investment calculations are correct and identify the assets that create growth and profitability, whether is people of machinery.
By doing this, you can efficiently build up a cash reserve and be prepared for the extra amount of cash and investment you’ll need for the business growth. You’ll also have the awareness of which investments are the most important to your business model in order to produce the best return of your investment.