Cash flow is king: 101

Black wallet with money popping out

There is only one fairly simple rule to business - cash flow is king. In fact cash flow is everything... But you only really discover that in a recession. Any muppet can make money during the good times, and then lose it all again when times get tough! I see endless seminars and books out there peddling the same stuff. It is not very often that you pick up a business book to be surprised. I'm not knocking what they're saying, because most of it is true. The funny thing is that what they are saying has been true for the last 1,000 years. It isn't new, just rebranded tens of thousands of times! So here are six rules for cash flow:

RULE 1:

Always be prepared to trade uncertain cash flow for cash flow today. For example, if cash flow is tight and you have fixed-rate investment loans (property or business) on high rates then think about breaking them and taking the cash flow advantage now. (You have the added advantage that the break fees are tax deductible.) I personally would also take low short-term rates over high long-term rates. (Note that my preferred rate at the moment is one year at 5.39%.) Broadly speaking, interest rates are tied to the state of our economy. As long as the economy flounders you can be fairly confident that short-term rates will stay low. If you survive now who cares about interest rates when the times are good again! I have the same view of tax – who cares about paying tax if you are making healthy profits? Too many people focus on the obstacle and not the goal.

RULE 2:

Be proactive. Always look after your cash flows. A friend went through his business revisiting all of his supplier costs and got them down 25%. This is not rocket science. If your business is fat then harden up and put it on a crash diet. If you need to sell a property sell the one with the worst yield. With one client I've suggested they sell the place they live in before selling one of their high-yield investment properties. Like them, chances are your owner-occupied place is not a great investment because the decision criteria would have been different when you purchased it. In other words, you probably bought with your heart, not with your wallet – unlike investment properties where the figures are always the first priority.

RULE 3:

Cut your losses and do not procrastinate. If your cash flows are going backwards then something needs to change fast. Waiting it out is more likely to make the situation worse rather than better.

RULE 4:

Cash flow is what makes fortunes (and a lack of it is what loses them.) The value of any asset is a multiple of its cash flow. For every dollar of ongoing cash flow you add to an asset you increase its value by between $4 and $15, depending on the perceived risk of the asset. On a rental property these are things that tenants value and are prepared to pay extra for. The reverse is also true. In business I think market innovation and brands are huge value and are often under-valued. If a business can generate a profit of $500k per year then it might be worth $2m. If the business is also growing its cash flows at 30% per year, then the business might be worth $5m now (or $17m in five years’ time.) One of the things I love about what we do at squirrel is getting to meet business owners doing just this! The other thing I love is that marketing is a tax-deductible expense and there is no capital gains tax on brands.

RULE 5:

Starting a business from scratch is hard work (and I know this from experience.) It is very easy to overestimate cash flow. For example, I didn't see the worst housing market in 25 years coming two months after I launched! Don't over-invest up front and always hold back at least 30% of your capital for contingency funds. I've seen businesses with great ideas fail because it takes time to build trust. Customers don't magically turn up when you open the doors.

RULE 6:

Making poor cash flow decisions in business is unavoidable. Simply be quick to spot the bad calls and correct them as quickly as possible.