Cash is King
Cash is everything in business.
Story #1
2AM
It was 2 o’clock in the morning and I was still wrestling with drafting the financial statements after two weeks since the date our bankers requested it. The balance sheet was still not balanced.
Fortunately, I at least had cash accounts (i.e. cash at bank and cash on hand) and control accounts of receivable, payable, and other items from our 15-member accounting team responsible for the job. To give you a bit clarity on the workload situation, the accounting team were fully occupied with billing tasks given we were handling a massive number of transactions with B2B customers and suppliers where we acted as a technology agent helping to connect and operate their shipments. Hence, I understood that the team would not be able to support me with preparing the financial statements although in general, they should be prepared by the chief accountant, not by me as the finance manager of the company. In the end, I managed to balance the balance sheet after a ton of reconciliations and justifications, and was able to submit the financial statements to our bankers. We successfully secured the loan afterwards.
I still remember like it was just yesterday when I had to build financial statements for my previous employer (a tech startup) without a full set of appropriate accounting books (I meant no general ledger or trial balances). We needed the financial statements as supporting documents to maintain a loan facility from a local bank at that time.
Life is not always easy, but simultaneously it always teaches us how to survive and grow stronger, especially under difficult circumstances. In fact, I believe I have learnt some tips from preparing financial statements without having a general ledger and trial balance (but with only cash accounts), and those tips have never been taught during my five years working at a Big Four auditing firm. Cash flows and their relationships with other financial statement items are the foundation of understanding a company’s financial health and fundamental concepts such as accounting equations are really the only thing we need to know (e.g. when a sales is recognized, a receivable would be recognized accordingly if cash has not yet been paid). Understanding cash flows could also help reveal lots of things e.g. the quality of earning and assets, corporate governance and financial management of a company. It is quite weird but true stories as I observed that many financial due diligence sometimes did not diligently assess cash flow statements, especially cash flows from operations and core business activities. Instead, income statements and balance sheets were generally the focus. The basic and important aspects are somehow neglected. How can cash flows reveal the corporate governance and financial management of a business? For instance, on 30 Dec of a year, equity capital was injected by shareholders and appeared on the balance sheet of that Company (it is worth noting that equity injection is generally a good signal e.g. gearing ratio decreases), but was immediately drawn down by the shareholders on 01 Jan of the subsequent year and again re-injected to the bank account of that business on 30 Dec of that subsequent year. In that case, cash is never used to fund the business, but help make up year-end financial statements. A company can report a very high revenue growth and profit generation but at the same time being under cash pressure year by year. Cash flow is also the starting point to trace back fictitious profit hidden under fictitious inventory and receivable. That said, profit could be manipulated by accounting tricks, but for cash flows, they were harder to fabricate (although I believe there are still many ways to do so!!).
Story #2
COVID-19 pandemic hit very hard on my previous company. Our fundraising was delayed for six months given our corporate investor also needed to review their financial plan and investment strategy during uncertain times. The company only had a few months of cash runway and was facing a serious liquidity situation. My most immediate tasks at that time included (i) identifying the problems on both financial and business sides, (ii) looking at the organization’s cash levels and whether or not its cash forecasting estimates are accurate and trying to make it the best estimated, and (iii) prioritizing and executing a business continuity plan to keep the business afloat. The critical points in the plan included (i) understanding deeply about factors impacting cash flows and business growth in the long-run to decide what is really necessary and what is not and could be cut (at least for that period!), and (ii) dealing with all stakeholders of the company (i.e. suppliers, customers, lenders, investors, and employees) to shorten cash conversion cycle, i.e. to collect cash from customers sooner using a systematic collection process and system, delay payments to suppliers, find new sources of external and internal capital, and stretch the timing of debt repayment obligations. We finally survived without the need of laying off any employees, and successfully raised millions of USD.
The basics of business are pretty straightforward — you look at forecast expenses and revenue and make sure the latter is not smaller than the former. If this does not seem to be the case for next month (or even shorter, let’s say next week), now is the time to get back to the basics. Forget about the financial metrics such as net profit after tax, EBITDA (or “adjusted” EBITDA as various companies are using it to make up their profitability results), return on investment and enterprise value, instead, it is important to focus on cash — how to get it and how to conserve it. Cash is everything in business, particularly when it is running out. A liquidity crisis caused by a crimp in cash flow is the beginning of the end for most companies.
Well, if you are put under a situation where your company is under financial distress, I believe you would be on the same page with me with regards to the importance of cash flows and why people usually repeat the slogan “cash is king”. In the time that the cost of capital is cheap, not many people are really concerned about cash flows until black swan events happen. Through this article, I shared some stories from my personal experience to (re)-emphasize the importance of (i) understanding cash flows and its impacts to financial statements as well as the whole financial picture of a business, and (ii) what really matters to a business and why cash is king. During uncertain times, businesses with sustainable operating cash flows could take this advantage to thrive in the future. If anyone asks me about the most critical factor I generally look for when assessing a business, I can immediately answer that it is cash flow.
