Businesses fail because they run out of cash – simple as that. Making a net profit is important, but if your cash is going out faster than it’s coming in then eventually you will run out, unless your friendly shareholders bail you out and put more in. Or your bank lends you some money, but watch they don't ask for your house as guarantee.
Sometimes the faster you grow the more risk you have of going bust - what you need is a positive cash flow.
It’s not uncommon in the early days to have to pay your suppliers upfront, which might be before or at delivery. That’s solid cash out of your business. Then you make a sale and your customers insist on paying you on ‘terms’, which could be 30, 60 or even 90 days after delivery.
So your customers are paying you a long time after you’ve paid your suppliers, which means your cash balance is going down, at a speed that is dependent on the margin you are making. A situation like that puts the business at risk and severely limits your growth potential, because you need more and more cash – called working capital – to fund your growth.
On the other hand, if your customers pay you immediately and you pay your suppliers on delayed terms then your suppliers are funding your cash requirements and the faster you grow the more cash you will have.
When you’re planning your business, your payables (cash out) and receivables (cash in) are critical. It’s very important to get the balance right to maintain positive cash. And the sooner you can establish a credit line with your suppliers, the better.
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