Understanding your cash flow and its importance

Posted on May 14, 2012. Filed under: Ryan Johanek |

Gone are the days of collateral based lending.  When businesses are looking to purchase a piece of equipment, construct a building, establish a line of credit, etc., financial institutions look primarily at the cash flow of the business.  Cash flow is the most important factor because that is the primary source of repayment on the loan.  Lenders look to minimize their risk by borrowing to businesses that can support the new debt based on their tax returns and income statements.  We still look at the character of the business owner, collateral that is being pledged, industry they are in or entering, the operating cycle, and structure of the loan, but those factors are not as important as the cash flow.  

Cash flow is the movement of money into or out of a business, project, or financial product.  It is usually measured during a specified, finite period of time.  Measurement of cash flow can be used for calculating other parameters that give information on a company’s value and situation.

It is extremely important for business owners to review their financial statements, get comfortable with them, and locate areas where they can make changes to help improve their profitability and cash flow. They should review their revenue streams to find areas that are profitable and try to expand them while cutting back on areas that are not.  They need to look for ways to lower cost of goods sold and examine expenses to find areas where the business can run a little leaner while still keeping the same quality and service. 

Not only does a strong cash flow help in obtaining financing from a financial institution, it will also help increase the value of the business when the owner is looking to sell.  A potential buyer is going to want to look at the financial history to determine a price they are willing to pay for a business.  They are looking to see how profitable the business is to justify the risk they are willing to take on.  Their lender is going to do the same and look at how much risk they want to take based on the historic numbers they are provided.


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