Income Tool Time

Why is cash so important to a business, or should it rely on net income? Use the benefits of shortening the cash conversion cycle to explain your answer. What is the best way for a company to increase its free cash flow, or should it just focus on increasing its net income?

The simple answer is – cash is king. A business can generate a ton a revenue, but if its customers do not pay on time regularly, that prevents them from paying vendors & employees timely as well as efficiently reinvest into the business to make it grow. Vendors do not care if your customers are not paying you, they want to be paid and will shut you off if they don’t. That means no inventory or supplies to keep making and selling product, eventually causing the business to fail. By shortening the cash conversion cycle, a business receives the cash back from their investment quicker. The cycle starts with the investment in inventory and labor, and ends when the cash from sales is received. Offering discounts to customers to pay early, negotiating favorable receivable terms, and stretching payments to vendors where possible are all tools to help shorten the cash conversion cycle. The quicker a company gets the cash back, the quicker they can pay off loans (thus saving interest), and reinvest into the business to help make it grow. Without solid cash flow, a business will find themselves borrowing more to keep operations going, but that will only last so long before it becomes insolvent.