It is a common mistake many Private Organizations (small and medium) commit. Decisions on expenditure are generally made based on cash flow without looking carefully into the source and the business purpose for which the funds have come in the first place. If you look into the above category organizations which eventually fail, one of the major reasons would be that when there was comfortable cash flow coming inconsistently, and operations were smooth, the decisions makers get an urge to splurge on luxury items like posh cars, expensive dwellings, etc and/or commence investing in unrelated businesses.

The sad part is that even the accounts department / internal audit department or advisors will not open their mouths and eventually they become part of the fragile success of the company. From the outside, by now the Organization and its owners would seem part of a successful business house leading a posh life.

When there are intermittent cash shortages, this would be bridged by short-term borrowings from friends, private financiers, etc, so that the lack of funds is not felt and does not hinder the now exuberant lifestyle of proprietors, partners, or directors.

Case Study

A young enterprising and enthusiastic entrepreneur along with his wife started a rubber-based Industry. They ran the business with a lot of diligence and commitment and their total involvement in the business slowly started bearing fruit. The business grew multifold and profit also doubled, tripled in a short time.

Along with the normal business, they also had some unaccounted business too, which resulted in a heavy inflow of cash which resulted in abundant liquid cash. The couple slowly started minting money.

A heavy part of the business orders was from Government sectors, orders which were sometimes got through some devious methods. Soon there was some inspection in the government agency and the Government stopped the release of payments for six months, as they could not release any funds until all accounts were settled.

By this time cash flow too dwindled and it started affecting the business as a good part of the transactions were cash-based. Meanwhile, to make matters worse there was a raid by the tax department as a major portion of funds were invested in luxury items by the owners. In toto the whole situation was unfavourable and cash flow was at its minimum. As a consequence, a lot of assets had to be liquidated and by the time the Government released the pending payments, the liabilities had mounted multiple folds.

Lessons to be learned

1. At any point of time in the business when there is cash flow, there should be a clear picture of the calculated liabilities too.
2. Cash flow when there is excess should be effectively utilized to settle loans and creditors so as to enjoy better settlement terms.
3. Cash flow should not be reflected as cash – it should be deposited in the bank as short-term deposits.
4. Loans – short-term loans should be preferred which should be settled earlier – this is better than investing in long-term assets.
5. At all times there should be professional and analytical projections of cash flow and a stock of liabilities on a rolling basis so that the inflow and outflow could be assessed and these kinds of figures will help one to keep in mind both the assets and liabilities.