Why Strong Margins Are More Important Than Cash Flow
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Conventional business wisdom states that turnover is vanity, profit is sanity, and cash flow is reality. And while this is true (very true), the focus on cash flow can become a distraction to what, in my opinion, is a more important focus.
I see cashflow issues as symptomatic of other, hidden elements of running a business properly. The most important lever of all is the creation of margin (gross profits) in your business.
Here are five pointers to consider.
1. Chasing cash flow can be a distraction
The underlying driver for creating margin is creating defendable, distinguishable value for a client. When you create defendable, distinguishable value, it translates into the ability to charge more for your products and services since, by definition, there are lower competitive forces at play along with a higher perceived value.
Higher margins translate into higher net profits and this, over time, goes a long way towards reducing the effects of bad cash flow management.
2. Create cash flow systems
When analysing the thousands of businesses to which I have been exposed over the last 18 years, I have seen that the majority of those experiencing cash flow problems have weak to non-existent cash flow systems. A few important systems and approaches can make all the difference in managing your cash flow better, and will give you more time to focus on creating defendable, distinguishable value.
These systems include: Budgets (that are used); creditors’ policies (that are implemented); a tough creditors’ clerk (who has no problem hunting down cash); and nurturing strong relationships with clients (in particular, with their accounts departments).
3. Margin increases resilience
Not only does margin create a cushion of cash that can be used to smooth over delinquent payers, but it also allows for a mindset of freedom to provide additional cost-bearing value-add to clients in emergency situations that require it, without any anxiety as to the overall profitability of the deal. This almost always leads to improved client relationships.
4. Margin increases the depth of core competencies
Some of the profitability generated by increased margin should, in my opinion, be channelled into deepening the core competencies of the business. Deeper core competencies reinforce the company’s defendable, distinguishable value-add which creates more cash — a virtuous cycle. This cycle needs to be jealously maintained and guarded.
5. Margin keeps the client at the centre of attention
When you focus exclusively on cash flow, you are — to all intents and purposes — focusing on yourself. Your energy is concentrated on insuring that you have sufficient funds to maintain the operations of your business.
When your priority is margin, your client becomes the centre of your business existence.
Your focus moves to their needs and solving their problems. This ensures longer-term, more profitable and stronger relationships with your clients. The result — given that proper cash flow systems are in place — is a business that does not experience cash flow issues.
The problem with conventional pieces of business wisdom is that they sound plausible and contain just enough truth for you to make them guidelines in your business.
Perhaps a deeper analysis of their true wisdom, and whether or not they are masking a cause or effect, will result in you adopting practices that are more valuable to your business in the long run.