Why adequate cash flow is key to business success
We often hear about the importance of the bottom line. This last line on a financial statement indicates an entity’s profit or loss, so the bottom line is a key focus for most businesses.
There’s no doubt that a company’s profitability is critical. Cash flow, however, may be equally important to the health of a business. From an internal perspective, poor cash flow can impact the business’s ability to operate. Without a healthy, adequate and consistent cash flow, a company can quickly find itself out of business. Poor cash flow also can prevent companies from accessing credit for needed capital. To a commercial lender, strong cash flow is a good predictor of a company’s ability to repay a loan.
After looking at thousands of cash flow statements of agencies of all sizes – both independent and captive – I’ve noticed that poor cash flow often is the result of five issues:
- Over-leveraged agencies. Many agencies have excessive debt and the resulting debt payments have a negative impact on cash flow. Agencies take on debt for a number of reasons – some good and some bad. Debt that seems to cause the most problems is for over-priced acquisitions, big mortgages on real estate and enormous credit card debt used to help cover regular operating expenses. Agencies should adopt conservative fiscal policies and carefully weigh decisions to take on certain types of debt. Knowing best practice financial ratios for your organization can be very helpful in maintaining a sound financial status.
- Over-leveraged agency owners. Sometimes insurance agency owners go overboard when it comes to their personal spending. After they pass the early years and experience more stability and success, they adapt more elaborate lifestyles. Expensive mortgages for nicer homes, recreational purchases and activities (like extra cars or boats), pricey vacations and other indulgences necessitate larger salaries that can drain the agency’s cash flow. What’s more, agency owners in these scenarios often turn to credit cards to support their lifestyle, leading to further debt. Sticking to best practice financial ratios, regardless of a principal’s desire for additional money, is the safe route to take in order to maintain healthy cash flow.
- Unpaid taxes. Withholding taxes may seem like a simple and common business practice, yet many agencies have cash flow issues because they fail to withhold taxes throughout the year. As a result, they take a financial hit when the tax bill comes due and their cash flow is significantly impacted. Even though it may be tempting to utilize funds that should be set aside for other expenses, it’s rarely a good idea. This is a discipline that may be difficult to keep in the early stages when businesses are often cash-strapped. To avoid a major cash flow disruption stick to a plan to withhold taxes on a regular basis.
- Over-invested agencies. Agencies with cash flow issues often invest heavily in strategies to grow their businesses, only to see little to no return on their investments. The investments are typically in producers, marketing plans and technology. This is where knowledge of how to best recruit and compensate the right talent comes into play. In addition, the right compensation structure is critical. Agencies also spend thousands of dollars on leads, but lack a good strategy to develop and capitalize on those leads. Or they spend too much on marketing technology, believing a sophisticated system is an effective strategy. Spending a lot on a fancy web site, for example, doesn’t automatically result in quality leads or new business needed to cover even a portion of the expense. Worse, some agencies sign contracts to receive services and find themselves locked into payments for services that don’t yield guaranteed results. While you do have to invest in growth, be careful and do your homework before making major decisions. Get evidence that investing in products and services will deliver an appropriate return.
- Failure to budget. Creating an operating budget and sticking to it is an important business practice. Most agents enter the agency business because they have an aptitude for sales. They aren’t necessarily strong in finance and many never have been exposed to the basics of accounting and business finance. Consequently, they may neglect to monitor and control revenue and expenses. Cash flow almost always suffers when owners lack a detailed understanding of the agency’s financial condition. Agencies should invest time and resources to ensure their business is in good financial shape and that cash flow is adequate to cover unexpected expenses. This will help the business thrive, and will position the agency favorably should there be a need to apply for credit.
This article originally appeared in PIA Magazine. Barry Kehl is Executive Director of Underwriting at Oak Street Funding, which provides commission-based lending for insurance agents that need capital to buy, build or sell their agency. He can be reached at email@example.com