Strong cash flow

Strong cash flow is the key to investment success.

Whether it be investing in one’s own business; investing in managed funds that in turn invest in other assets such as property or shares; whether it be individuals investing in residential property investments or commercial property investments; small businesses; large businesses; they all require strong cash flow to achieve investment success.

Household budget is just as important.

When the household budget is properly managed with strong cash flow management at play, life is much easier. The anxiety and stress that accompanies poorly managed household budgets is absent. Life is good.

The household budget

For households, good cash flow means there is enough money to pay the bills, to have some left over and to be able to save.

Sure, for those whose income levels are low, having enough left over might be more challenging but indeed, is all the more reason for strong management of that household budget.

Also it might be an idea to ask the question … “But why is my/our income so low?”

The business owner / operator

Small businesses rely absolutely on cash flow from their operations. Running out of cash flow is the quickest way to kill off a small business.

It is important for small business owners to distinguish between profit and cash flow.

This can be a trap for the uninitiated. Sometimes novice business owners make the mistake of thinking that the accounting profit is the same as cash flow or money to spend. No it is not.

Sometimes small business owners do not realise that what is showing as profit in the income statement is sometimes sitting in plant and equipment, motor vehicles, computers or growth initiatives that have used up some of the cash that flowed but nonetheless, it still shows as profit regardless. Does that make sense?

Profit is good but cash flow is critical for small businesses.

Rental properties

Whether it’s a residential property or a commercial property, cash flow underpins the real value of a property (as opposed to the rateable value, the bank’s valuation or even a registered valuer’s valuation). The “intrinsic value” if you like, of a property relates to its cash flow.

A wide gap between the cash flow and the rental income of a property between the capital value or let’s say the purchase price means a property could be expensive or over-priced – quite common in a liquidity bubble driven environment.

Whilst a residential property or a house without a tenant may not be so impacted by the lack of an income stream because people can live in a house, an industrial or commercial property relies significantly on having a tenant and having cash flow to support the actual value of the property.

For a number of commercial and industrial properties, no tenant means a significantly marked down value for the property.

Big businesses / Direct shares

Whilst big businesses sometimes have greater capacity to override or even “bluff their way” through cash flow difficulty, without sufficient cash flow, inevitably those businesses’ trading prices on the market will be marked down strongly and quickly should any news of cash flow problems emerge.

Whilst big businesses listed on the markets are perhaps more complex than other types of investment, they are no different when it comes to cash flow.

A free cash flow that is retained by the business and reinvested at a high return on equity or a higher return on capital is an investment worth considering.

Those businesses with minimal debt and a strong position in their market niche will likely show strong unencumbered free cash flow consistently. They may also grow. That means the cash flow will also grow. Investing in that type of business can be quite profitable, particularly over time.