Cash is a Necessity and Not a Luxury

Some companies think they are financially strong because they have lots of assets. But the makeup of those assets makes a big difference. What do I mean by that?

Can You Spend It

I touched on this earlier in the posting Cash Flow – The Bottom Line. While there is certainly something to be said for other kinds of assets, such as accounts receivable and inventory, eventually they mean nothing unless they can be converted to cash. Oh, there are exceptions like trading assets for a needed product or service, but that is not the norm. It is important to remember the business cycle. If you are selling products then you either make them or buy them and then sell them. When you collect the cash from the sales you use it to pay for the products you sold or other goods and services. Unless you collect at the time of sale you will have a customer receivable that must eventually be collected. If you don’t collect it then you will not have the cash to pay your bills. So as you can see, cash is a necessity and not a luxury. In general you cannot spend any other assets.

cash pile

An Ability to Generate Cash Will Impact Credit

If you are trying to obtain credit with a vendor then they will likely want to see some financial information. When they look at your balance sheet they don’t want to see an accounts receivable balance that averages 90 or 120 or more days outstanding. Likewise, they don’t want to see an inventory balance that is a four or five or more month supply. This is an indication that your assets are not being managed well and that you are not producing cash in a timely manner. When you are unable to get credit and have to pay cash with order or COD you will realize just how true it is that cash is a necessity and not a luxury.

The Unexpected

Besides the routine day-to-day needs for cash, there are also special situations where it pays to have a reserve of cash. For example, imagine you bought a rather large supply of inventory in anticipation of significant holiday sales. If those sales do not materialize and you cannot return the inventory, just how do you think you will pay for the inventory? This is one of those times that having a little extra cash on hand can mean the difference between staying in business or closing your doors.

Another reason you might want extra cash around is to take advantage of special opportunities. Imagine a supplier is offering a special on products you sell that are always in demand by your customers. However, the special deal from your supplier may require a 50% down payment or even full payment up front. Will you be in a position with your cash to take advantage of this deal?

Before you get too comfortable with having a lot of assets, consider whether they can be converted to cash quickly as it is true that cash is a necessity and not a luxury.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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