An overwhelming majority of small businesses around the world fail within five years of launch. With 70% to 80% of small business failing in the first five years, according to the University of the Western Cape, South Africa is no exception. Although there are several reasons why South Africa has one of the highest rates of start-up failures in the world, cashflow is, and possibly will always be, the leading reason why small businesses fail to stay afloat. The best investment that local entrepreneurs can make into the sustainability and growth of their venture is to understand how cashflow works and how to get better at it.
This is the opinion of Rene Botha, Regional Investment Manager at Business Partners Limited who makes reference to the most recent finding by the Statista Research Department, which reveals that the main reason for small business closure relates to running out of cash. “There are very few universal truths when it comes to running a successful small business, because so much depends on variable factors, as well as the convergence of micro- and macroeconomic market influences. Cashflow management, however, is without question the most important aspect for any small business.
Not only has this been confirmed on a global level by a number of studies, it is something we at Business Partners Limited have also seen with some of our clients. Over 42 years of working with small businesses of different kinds and across a wide range of sectors, as well as looking at the findings of our own research study, the quarterly Business Partners Limited SME Index, we have concluded that cashflow is the number one challenge for local small businesses.”
Cashflow vs. profitability
When talking about cashflow and what it means within the context of an SME, many may mistakenly relate it to profitability. However, although both metrics are inter-related and are important measures of a business’ financial standing, there are a few key differences.
Cashflow deals with the movement of funds in real time, both in and out of the business. It therefore includes actual cash transactions, including cash received from customers, cash paid to suppliers, employees, and other expenses. As such, it considers both operational cashflow (day-to-day business activities) and investment cashflow (capital expenditures and acquisitions) as well as financing cashflow (loans, equity investments, dividends).
Positive cashflow indicates that a business has a healthy level of liquidity and can meet its short-term obligations. Negative cashflow, on the other hand, signals that the business is spending more than it is earning, potentially leading to liquidity problems.
In contrast, profitability focuses on the company’s ability to generate profits from its operations. Essentially, it is the difference between the total revenue generated from sales and the total expenses incurred, including cost of goods sold, operating expenses, taxes, and other non-operational expenses.
Profitability is often expressed as net income, which is the bottom line after deducting all expenses from revenue. A profitable business is one that earns more revenue than it spends on operating and non-operating costs, resulting in positive net income. However, profitability alone does not guarantee sufficient cashflow, as certain expenses may not involve cash outlays and revenue might not be collected in cash on an immediate basis.
Why good money management practices are a must
Touching on why maintaining good cashflow is integral to the success of a small business, Botha explains: “Positive cashflow ensures that a business can meet its day-to-day operational expenses, such as rent, utilities, inventory, and payroll. It means that SMEs can pay their suppliers timeously and maintain those all-important relationships. Healthy cashflow is also a buffer against market volatility and unexpected events, allowing small businesses to handle emergencies and maintain stability during tough times.”
She adds that apart from the operational implications, there is also a long-term view to consider. “Opportunities for growth and expansion often arise unexpectedly. Having adequate cashflow enables a business to invest in new equipment, marketing initiatives, or strategic acquisitions, allowing it to capitalise on opportunities and gain a competitive edge when it matters most.
It is also a vital contributing factor to whether small businesses are eligible and able to secure finance in the future, because investors and lenders are more likely to support a business with a strong cashflow track record and projections.”
Tips on how to manage your cashflow effectively
Botha has some tips on how to maintain optimal cashflow, which all come down to some disciplined procedures. For example, business owners should ensure that invoices are sent out promptly and that customers are encouraged to pay in full and on time. This could be done by offering discounts on early payments and other special arrangements. On the flip side of this, small businesses should also work with suppliers to negotiate payment terms that align with their cashflow cycle. Requesting extended payment terms or exploring vendor financing alternatives, if possible, are options to explore.
SMEs should also plan around seasonality, by making provision for leaner sales periods and using a cash reserve to make sure that basic operational expenses, such as staff compensation are covered during the slower months. Furthermore, if your business carries debt, focus on paying off high-interest loans first to reduce interest expenses and improve cashflow.
As Botha concludes: “If cashflow management is challenging, consider consulting with an advisor who can provide valuable insights and guidance. Ultimately, by prioritising cashflow management, small business owners can maintain financial stability, foster growth, and secure their ventures’ long-term success in an unpredictable and ever-changing market.”
About the Author: René Botha
