Or is it?
If you’ve been around business for any length of time you’ve certainly heard someone say “Cash is King.” But, is cash flow really the primary measure of the financial health of a business?
One thing is for sure, if you understand the historical cash flow statement you understand the comings and goings of cash from income statement and the balance sheet. When a business starts or expands it needs to have enough cash to buy equipment, hire and train staff, build inventory, and market LONG before sales start coming in.
Cash is indeed King when a business is starting or expanding OR if you mismanage your cash and don’t have enough to function. However, there are many situations where your business can be flush with cash while in the process of going down the drain.
For example, let’s say you are at the end of the quarter and you decide to show excellent cash flow numbers. It’s possible to stop paying your vendors, deplete your inventory, and not offer sales on credit in order to do that. BUT, is that smart business? Many times in your business cycle you can either be flush with cash or low on cash and that has nothing to do with the long-term health of your business.
In the long term, Profit is King. That is, the ability to provide your product or service at a price that returns enough profit to pay your expenses and keep you in business. Of course, this also involves managing receivables, inventory, and payables at healthy levels in order to continue to function.
Focusing on a single measure of financial health is clearly not enough. Instead, you need to periodically look at the big financial picture by analyzing pricing, costs, balance sheet levels and return to you and your investors.
Cash is King? It’s simply more complicated than that.