The recent announcement that President Obama is urging large companies to make faster payments to their small-business vendors has shed light on an important topic. Through the proposed initiative, “Supplier Pay,” the federal government is acknowledging one of the central issues that American businesses face: namely, getting paid on time. Whether or not you think the initiative will have a significant effect, it is an important conversation starter. At the very least, it allows for an opportunity to discuss the critical nature of cash flow in a business, especially as driven by the Accounts Receivable.
When you sell a product or service and generate a dollar of revenue, that economic good for your business is captured through either the receipt of cash or through selling “on account.” When you sell “on account,” you create accounts receivable—i.e. revenue earned, but not yet collected in cash. Most business owners understand the difference between cash and accounts receivable, but there are subtle differences in managing the two that many businesses slip up on. When I was consulting small businesses on their finances and business plans (now decades ago), I learned, what was to me, an incredible fact: Most businesses are profitable. They actually do generate more sales that are higher than their expenses. However, profitability and cash flow are two very different things. I was, and remain, amazed at how many profitable companies are strangled by negative cash flow.
Related: Why You Should Be Using Your Accountant for More Than Taxes
There is a strong tendency among business people to manage companies from the “bottom line.” Unfortunately, you don’t pay bills from the bottom line -- you pay them from positive cash flow. Take a lemonade stand: Let’s say daily sales for the stand are $100 and current expenses are $50. Further, let’s assume that all expenses are cash expenses— items such as lemons, sugar, and water. That’s a 50 percent Net Profit Margin. Not bad, right? Here’s the distinction: If the stand’s proprietors are asking for cash sales only, aside from their healthy profit margin, they’re generating positive cash flow of $50 (sales of $100 cash minus expenses of $50). If, however, the stand is making sales exclusively “on credit,” they’ll have negative cash flow of up to $50 (sales of $0 cash minus expenses of $50). A 50 percent net profit margin on paper means nothing without positive cash flow.
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