Small Business Financial Health: Cash Flow Management vs. Diversification
These days, it is impossible to come online without seeing someone hawking some kind of investment or the other. Due to the limited knowledge of financial literacy, land speculation seems to be the most offered investment advice to small businesses. I guess that ownership of land has become a bragging right, and anyone who has none feels accomplished.
Aided by this faux pax, many small businesses put up their investment into land assets without having a long-term overview of their business. Small businesses need all the money they can get to survive. Most often, small businesses are new businesses searching for stability. According to the U.S. Bureau of Labor Statistics (BLS), approximately 20% of new businesses fail during the first two years of being open, 45% during the first five years, and 65% during the first 10 years. Only 25% of new businesses make it to 15 years or more.
A lot of these failures arise from the limited financial literacy of those running the startups, thus permitting them to make mincemeat of their cash flow management. For the sake of this post, I will take small businesses to mean businesses having an annual turnover of N25m, which coincides with businesses that have been exempted from VAT by the FG of Nigeria
On the other hand, cash flow refers to the management of inflow and outflow of cash- income and expenditure for a business. Cashflow is a significant method to determine how financially healthy a business is.
The Importance of Cash Flow Management
Cash flow management is the process of tracking and managing the inflow and outflow of cash in your business. It’s what keeps your business running smoothly, allows you to pay your bills on time, and enables you to invest in growth and expansion. Effective cash flow management helps you:
– Meet financial obligations
– Invest in new opportunities
– Weather financial storms
– Build a strong credit score
– Make informed business decisions
5 Reasons to Prioritise Cash Flow Management over Diversification
- Land Assets Don’t Earn Income
Investing in land or any other long-term assets may be profitable in the long term, but it doesn’t generate income for your business, reducing cash flow and potentially deteriorating financial health.
Investing in land is a good investment, especially when there’s hyperinflation. However, land is not an earning asset that a business can use to improve its cash flow. Land is often a long-term investment where the investor profits through capital gains. For small businesses, investing in land assets or any other assets that does not yield an income term reduces the cash flow of that business and might lead to the deterioration of the financial health of that business.
New businesses need to consistently improve their cash flow, and any business not capable of scaling its cash flow should be jettisoned
- Diversification Reduces Working Capital
While diversification is essential, it can lead to accelerated burnout of working capital, distracting from your core business model and reducing cash flow. New businesses need to focus attention on their business model and ensure it generates sufficient returns before turning their attention elsewhere. Diversification tends to move cash to other new ideas with little to no supervision, ensuring that that cash gets burnt.
- Revenue is Not Profit
Revenue and profit are often confused, leading to reckless spending and unhealthy cash flow management. Understand the difference: Revenue is the summation of all cash inflow into a business. Some businesses do very little to separate profit from revenue and assume both to be the same. Because they assume revenue to be profit, they get carried away and spend this revenue recklessly, creating an unhealthy cash flow for the business
– Revenue: total income from sales
Profit: revenue minus expenses
- Reduced Chance of Getting a Loan
Investing limited cash flow into other businesses diminishes your chances of securing loans or grants. Lenders prioritise businesses with healthy cash flow. As a new business, your cash flow is the most necessary document when seeking a loan or grant. Investing your limited cash flow into other businesses diminishes your cash flow and reduces the probability of getting a loan or attracting investments
- Investing in Your Business is Most Appropriate
Investing and expanding the cash flow of your business is the most appropriate thing for any small business. When you expand the capacity of your business, your cash flow increases and, most likely, your profit. From your profit, you can diversify to other businesses
– Investing in marketing
– Hiring new talent
– Upgrading equipment
– Expanding product lines
Conclusion
In conclusion, small businesses should prioritise cash flow management, focusing on expanding their core business model, generating income, and building a solid financial foundation before diversifying. By doing so, you’ll ensure long-term financial health and success.