Why Cash Flow Is More Important Now Than Ever For Small Businesses
Hello! My name is Tyler Sindel, and I am a current graduate student at the University of Notre Dame. I am originally from Brick, New Jersey! I have an interest in the Accounting/Finance industry. I am looking to expand my knowledge as part of the Stuff Your Accountant Isn't Telling You podcast! Thank you for reading.
This blog post was written in response to the Stuff Your Accountant Isn't Telling You Episode "Four Things That Can Improve Your Business Cashflow" here.
After reflecting upon what was said in the podcast, I would like to add some other information regarding cash flows and their importance. Jumping right into some current events or economic turmoil, the interest rate hikes we have seen in the past year have a great deal to do with cash flows. The importance of cash flows could not be more crucial in assessing if a company will survive through interest rate hikes.
The "Cash Generators"
Coming from a time when the Federal Funds rates were near zero during the pandemic, money was cheap to borrow and used to generate money. As Lola spoke about, these “cash generators” are aspects to a company that are necessary to spend money to make money. Tech companies or those heavily invested in research and development spend a ton of free cash flows on these “cash generators.” Moreover, startups or companies in financial distress would be using debt to help finance these operations.
"Expensive" Debt Just Got More Expensive
With the federal fund rates increasing through 2022 and into 2023, the interest expenses of companies are getting inflated. The ability to maintain healthy and heavy cash flows allows a company to navigate the dangerous waters of rising interest rates. This “expensive” debt is a direct hit on a company's cash flow statements, which indirectly devalues the company’s earnings every year which lowers the value of the company itself.
"The ability to maintain healthy and heavy cash flows allows a company to navigate the dangerous waters of rising interest rates"
Hedging During Distress
Aligned with the ability to pay off debt, companies need cash flows to function their investing initiatives. Aside from investing in new production or research and development, the ability to hedge during times of distress is an important factor for companies. With inflation coming off a 40-year high, the cost of inputs to produce goods has been greatly impacted. Free cash flows, which allow companies to enter derivatives such as options, is a way to avoid some of the expenses that come with inflation. Some other derivatives entered are interest rate swaps, futures, and or forwards. Some of these derivatives do not require initial investment such as a forward, which gives a company or user of a forward to lock in expenses/profit in the future. A company that owns restaurants entering a forward for the price of beef in a year needs healthy cash flows to effectively pay these forwards when due. Conversely, with a derivative such as an option, companies need the ability to pay premiums upfront to hedge or speculate future events.
What it all comes down to
Besides knowing what money is coming in or coming out, having knowledge of the health of your cash flows pays dividends. For companies, healthy cash flows create a more attractive investment for investors in your company. Healthy cash flows allow profit through investing in higher-yield investments during a time of high-interest rates such as bonds. It is important to focus on these areas within a business. It is as important to learn and focus on these areas when looking to invest in a business.
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