February 6, 2025 l Manila Bulletin
Cash flows are extremely important for businesses because they provide insight into a company’s financial health and ability to meet short-term obligations, invest in its future growth, and return value to its shareholders.
When most business stock analysts are asked, they’ll tell you they always focus on free cash flow to get a better picture of the cash generation capability of the business entity. Free cash flow is a valuable measure of financial performance that tells a better story than net income because it shows how much money the company has to expand its business, pay its dividends, or pay off its debts.
According to analysts, profit figures are easier to manipulate because these include non-cash line items such as depreciation expenses or goodwill write-offs under generally accepted accounting principles (GAAP); businesses can use non-cash costs such as depreciation and amortization to offset large capital expenditures.
Another important consideration is that profit reports are based on sales income. The difficulty here is that the record revenue is often greater than the actual cash received from sales. When sales are on credit, the accounts receivable collection period can last two to three months. To be sustainable, any business must pay special attention to its cash cycle and ensure it covers the cash gap between receivables and payables. Obviously, most companies don’t always follow this.
Unlike accounting profits that can be influenced by non-cash transactions (like depreciation or inventory changes), cash flows reflect money’s actual inflows and outflows. Cash flows are indeed better indicators of a company’s financial health. Profits appear good, but they do not adequately represent the financial strength of a given firm. It is possible for a company to report profits yet may not be able to grow or attract more investors in the near future.
When analysts, therefore, say cash is king, it means strong cash flows of a business that allow it much flexibility as regards its business decisions and potential expansions. “Cash is king” as a phrase means the superiority of cash over other assets or forms of payment. As a part of any company’s liquidity management, it is important not to let cash stay idle but always be invested so that, at least, the cash returns must be equal if not even higher than the inflation rate.
More importantly, preserving cash is one way to strengthen the corporate bank account. Cutting costs is another. Every type and business size, when necessary, must slim down to shape up. How to spend the money is critical to any cash flow management. Business, after all, cannot control income, but it can control expenditures. Cost-cutting is the surest, fastest route to financial stability.
To ensure the success of any good cost-cutting program, these five steps must be followed: (1.) Set specific cost-cutting goals. Set goals for the department and the entire organization; (2.) Challenge every expenditure. Never assume one can’t squeeze more savings; (3.) Identify all areas in which one can cut costs; (4.) Implement cost-cutting immediately. Don’t procrastinate; (5.) Follow up continuously on each cost-cutting measure to assess the impact on the business.
If the business goes out of cash, operations may cease. This is why cash flows provide a better sense of a business’s financial situation. Companies must prepare for cash outlays to exceed cash inflows, particularly during the early stages of business expansion. Think about it this way: to generate growth in sales, a business must first be able to afford an expansion in capacity.
***The views expressed herein are his own and do not necessarily reflect the opinion of his office as well as FINEX. For comments, email abelardo.cortez7@gmail.com. Photo is from Pinterest.