Cash flow is the key to keeping small businesses afloat

René Botha | 04 August 2023

René Botha is a Stellenbosch-based regional investment manager at Business Partners Limited. Her areas of expertise include business finance, female entrepreneurship, and the hospitality and tourism industry.

An overwhelming majority of small businesses around the world fail within five years of launching.

South Africa is no exception, with 70% to 80% of small businesses failing in the first five years, according to the University of the Western Cape.

Although there are several reasons why South Africa has one of the highest rates of start-up failures in the world, cash flow is, and possibly will always be, the leading reason why small businesses fail to stay afloat.

The most recent finding by the Statista Research Department confirms that globally 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. Cash flow management, however, is without question the most important aspect for any small business.

Business Partners has been working with small businesses of different kinds across a wide range of sectors in South Africa over a period of 42 years.  Using information gleaned from this period, as well as looking at the findings of their own research study, the quarterly Business Partners Limited SME Index, Business Partners has concluded that cash flow is the number one challenge for local small businesses.

The best investment that local entrepreneurs can therefore make into the sustainability and growth of their venture is to understand how cash flow works and how to get better at it.

Cashflow vs profitability

Many people wanting to run their own businesses mistakenly think that cash flow relates to profitability. However, although these metrics are inter-related and are important measures of a business’s financial standing, there are a few key differences.

Cash flow 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.

Business owners need to consider both operational cash flow (day-to-day business activities) and investment cash flow (capital expenditures and acquisitions), as well as financing cash flow (loans, equity investments and dividends).

A positive cash flow indicates that a business has a healthy level of liquidity and can meet its short-term obligations. A negative cash flow, 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 the 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 cash flow, 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

Maintaining a good cash flow is integral to the success of a small business because a positive cash flow ensures that a business can meet its day-to-day operational expenses, such as rent, utilities, inventory and payroll.

A good cash flow means an SME can pay its suppliers timeously and maintain those all-important relationships.

A healthy cash flow is also a buffer against market volatility and unexpected events, allowing small businesses to handle emergencies and maintain stability during tough times.

Apart from the operational implications, there is also a long-term view to consider. Opportunities for growth and expansion often arise unexpectedly. Having adequate cash flow 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 factor in determining 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 cash flow track record and projections. Read more: Where can I get funding to start a business?

How to manage your cash flow effectively

Maintaining an optimal cash flow comes 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 cash flow 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 cash flow.

If cash flow management is challenging, consider consulting with an advisor who can provide valuable insights and guidance. Ultimately, by prioritising cash flow management, small business owners can maintain financial stability, foster growth, and secure their ventures’ long-term success in an unpredictable and ever-changing market.