Executive Insight #021 A Good Decision Can Still Consume Cash

Why the Immediate Cash Effect Doesn't Tell You Whether a Business Decision Was Right

Estimated Reading Time: 8 Minutes

Key Insight: A decision that consumes cash is not automatically a bad decision, just as a decision that generates or preserves cash is not automatically a good one. Businesses create value by deploying resources. The management challenge is to understand what a decision requires financially, what it is expected to accomplish, and whether the tradeoff makes sense for the business.

Executive Observation

There is a temptation when talking about cash flow to make every decision sound simple.

More cash is good. Less cash is bad.

Reduce inventory. Collect receivables faster. Spend less. Delay capital expenditures. Avoid debt. Keep more money in the business.

If managing a company were that straightforward, cash-flow management would be easy.

It isn't.

Businesses exist to deploy resources. They invest in people, inventory, equipment, technology, products, customers, facilities, and growth because management expects those investments to strengthen the company or create future economic value.

Many of those decisions consume cash before they produce a benefit.

Some consume a great deal of it.

That does not make them bad decisions.

The important management question is not simply:

Will this decision use cash?

It is:

What will this decision require financially, what do we expect it to accomplish, and is the tradeoff worthwhile?

That is a much more useful way to think about cash flow.

Businesses Have to Use Cash to Create Value

Imagine a manufacturer operating near capacity. Demand is strong, customers are waiting longer for orders, and management believes the opportunity will continue.

The company could preserve cash by doing nothing.

Or it could invest in equipment that increases capacity.

The equipment requires cash. Installation may require additional cash. Employees may need training. Production may be disrupted temporarily. The expected return may take years to develop.

From a short-term cash perspective, doing nothing looks better.

From a business perspective, doing nothing may be the weaker decision.

The same principle applies to inventory. A distributor could reduce inventory aggressively and release cash. But if inventory falls below the level required to serve customers reliably, the company may lose sales, damage relationships, increase emergency freight, and weaken its competitive position.

Cash was improved.

The business may not have been.

That distinction matters because cash flow is a management result, not the sole objective of management.

The Timing of Value Matters

One reason good decisions can look financially uncomfortable is that the cash requirement and the expected benefit often occur at different times.

A new employee begins receiving a paycheck immediately. The capability that person brings to the organization may take months to become fully productive.

A new product requires development, tooling, inventory, marketing, and working capital before meaningful revenue develops.

A major customer may require additional inventory and receivables before the relationship produces substantial cash.

Equipment may require a large investment today while generating productivity improvements for years.

A new facility can require significant capital before the business grows into the additional capacity.

In each case, the company is exchanging financial capacity today for an expected benefit tomorrow.

That is what investment is.

The existence of a cash outflow therefore tells management very little about the quality of the decision by itself. Management needs to understand the expected return, the timing, the risks, and the company's capacity to support the commitment.

Growth Is One of the Best Examples

Suppose a product company has an opportunity to increase revenue substantially with a large new customer.

The customer appears profitable. The relationship fits the company's strategy. Management believes it can execute successfully.

But before the company receives the full economic benefit, it may need additional raw materials, finished goods, labor, warehouse capacity, freight, receivables, or equipment.

The business may become more profitable while its cash position becomes tighter.

That does not necessarily indicate a cash-flow problem in the conventional sense. It may indicate that the company is financing growth.

The distinction is important.

Management should certainly understand how much cash the growth will require, where that cash will come from, how long it will remain committed, and what happens if the expected growth develops more slowly than planned.

But rejecting a sound growth opportunity simply because it consumes cash would make no more sense than accepting every growth opportunity simply because it increases revenue.

The decision has to be evaluated as a whole.

Cash Preservation Can Also Be Expensive

The reverse side of this issue receives less attention.

Some decisions preserve cash immediately while creating larger costs later.

Postpone necessary equipment maintenance and cash remains in the bank today. The eventual repair or production interruption may cost substantially more.

Delay replacing obsolete technology and the company avoids an investment.

Employees may continue wasting time working around inadequate systems.

Reduce inventory below reasonable operating requirements and cash is released.

Customer service may deteriorate.

Leave an important position unfilled and payroll remains lower. The owner or management team may continue performing work that prevents them from addressing more valuable priorities.

Decline every capital investment and the company can preserve substantial cash.

Eventually, it may also preserve an outdated business.

Short-term cash preservation and long-term business strength are not always the same objective.

Good management has to understand the difference.

Debt Illustrates the Same Principle

Debt is another area where simplistic conclusions can create poor decisions.

Borrowing increases cash.

Repaying debt consumes cash.

Neither fact tells you whether the underlying decision is good.

A company can borrow money to finance an investment that creates substantial value. It can also borrow money repeatedly because operations are not generating enough cash to support the business.

The first situation may strengthen the company.

The second may weaken it.

Likewise, aggressively repaying debt can reduce financial risk, interest expense, and future obligations. But using nearly all available cash to eliminate debt could leave the business without enough financial flexibility to handle normal operating volatility or pursue an attractive opportunity.

The appropriate decision depends on the circumstances.

Again, the cash movement tells only part of the story.

Every Decision Involves a Tradeoff

This is the larger principle.

Business decisions allocate limited resources among competing uses.

Cash invested in equipment cannot simultaneously be used to build inventory.

Cash retained as a financial reserve cannot simultaneously be distributed to the owner.

Cash used to repay debt cannot simultaneously fund an acquisition.

Cash invested in additional inventory may improve customer service while reducing financial flexibility.

Extending customer terms may help win business while increasing working-capital requirements.

Those are not accounting problems.

They are management tradeoffs.

The role of cash-flow thinking is not to eliminate the tradeoff by automatically choosing whichever alternative leaves the most cash in the bank.

It is to make the tradeoff visible.

Management can then decide whether the expected business benefit justifies the financial commitment.

This Is Why Context Matters

Imagine two companies each spend $1 million on new equipment.

The cash-flow effect is identical.

The business circumstances may be completely different.

One company may be replacing unreliable machinery that is disrupting production, increasing labor costs, and threatening customer service. The other may be purchasing capacity based on an aggressive growth forecast that has not yet been supported by customer demand.

The same $1 million cash outflow carries very different risk.

Now imagine two companies each reduce inventory by $1 million.

One identifies obsolete and excess stock that has been accumulating for years and improves purchasing discipline.

The other cuts fast-moving inventory needed to serve profitable customers.

Again, the immediate cash result is identical.

The business result may be dramatically different.

This is why I believe cash-flow analysis should improve management thinking rather than replace it.

The number matters.

But the decision still requires judgment.

Financial Capacity Changes the Decision Environment

There is another dimension to this issue.

A business with strong cash generation and adequate financial capacity can make a cash-consuming decision differently from a business already operating under severe financial pressure.

Both companies may identify the same attractive equipment investment.

One can fund it while maintaining sufficient liquidity for normal operations and unexpected events.

The other may have to exhaust its borrowing capacity or reduce already limited cash reserves.

The investment itself has not changed.

The company's ability to support the investment has.

That distinction becomes increasingly important as we move from the first half of the BusinessWiser™ Dynamic Duo—the decisions that influence cash flow—to the second half: the options that stronger cash flow can create.

Financial strength doesn't tell management which investment to make.

It can determine which investments are realistically available for management to consider.

Executive Reflection

Think about a significant decision your business is considering right now.

Perhaps it involves inventory, equipment, people, technology, a new customer, additional capacity, debt, a new product, or expansion into another market.

Instead of beginning with:

How much cash will this use?

Ask a broader set of questions.

What financial resources will the decision require? When will those resources be required?

How long could the cash remain committed? What benefit do we expect the decision to create?

When should that benefit become visible? What assumptions are we making? What happens if those assumptions are wrong?

And what other options become unavailable once we commit the resources?

Those questions do not guarantee the right decision.

Nothing does.

But they create a much better management discussion than treating the immediate cash effect as the decision itself.

The BusinessWiser™ Perspective

One of the important qualifications in Most SMBs Don't Have a Cash Flow Problem™ — They Have a Decision Problem is that the objective is not to make every business decision based on its immediate cash effect.

Businesses exist to deploy resources productively. Some of the best decisions management makes may require substantial cash before the benefits appear. A decision can consume cash today and create value tomorrow. It can strengthen one part of the business while increasing financial requirements somewhere else.

That is why the Decision Problem is not a prescription for maximizing cash at every moment.

It is a framework for improving visibility into the relationship between business decisions and their financial consequences.

Management still has to exercise judgment.

Should we carry the additional inventory?

Should we make the capital investment?

Should we pursue the customer?

Should we hire the employee?

Should we borrow?

Should we distribute the cash or retain it?

The answer cannot be found solely by asking which choice produces the most cash today.

The better question is whether management understands the tradeoff it is making—and whether the business has the financial capacity to make it.

That distinction leads directly toward the second half of the Dynamic Duo.

Because stronger cash flow has value beyond the cash itself.

It can give management more viable choices about where and when to deploy it.

Related BusinessWiser™ Resources

Executive Guide: Most SMBs Don't Have a Cash Flow Problem™ — They Have a Decision Problem

Executive Guide: Cash Flow Creates Options™

Executive Tool: One-Page Net Cash Flow Driver Report

Framework: CASHfloWiser™

Framework: DRIVERwiser™

Podcast: Executive Insight #021 — A Good Decision Can Still Consume Cash

Final Thought

A business that never uses cash may preserve its bank balance.

It may also stop investing, stop improving, stop growing, and eventually stop competing.

The objective is not to prevent cash from leaving the business.

The objective is to understand why it is leaving, what the business expects in return, and whether the financial commitment makes sense.

Some poor decisions consume cash.

So do some excellent ones.

And some decisions that improve cash today can weaken the business tomorrow.

That is why the immediate cash effect cannot be the final judgment on a business decision.

Cash tells you what the decision requires financially. Management still has to decide whether what it creates is worth the investment.