Executive Insight #023 Ten Places Where Decisions Become Cash Flow

Why the Cash Flow Drivers Are Places to Investigate—not Numbers to Optimize in Isolation

Estimated Reading Time: 8 Minutes

Key Insight: Cash flow is influenced by decisions throughout the business. The ten Cash Flow Drivers provide management with a practical map for understanding where those decisions become financial results. Their purpose is not to tell you automatically what to change. Their purpose is to help you know where to look—and what questions to ask.

Executive Observation

When cash flow changes materially, owners naturally want to know why.

Sometimes the answer appears obvious. A major piece of equipment was purchased. A large customer paid late. The owner made a substantial distribution. The company borrowed money.

But many times there is no single explanation.

Revenue increased. Margins moved. Inventory changed. Receivables grew. Expenses increased. Supplier terms shifted. Capital spending occurred. Debt changed. Several things happened simultaneously, and together they produced the cash-flow result.

That can make cash flow seem complicated.

It doesn't have to be.

Over the years, I've found it useful to organize the major influences on cash flow into ten areas:

Growth. Pricing. Cost of Goods Sold. Operating Expenses. Inventory. Receivables. Accounts Payable. Capital Expenditures. Debt. Owner Distributions.

I call them the Ten Cash Flow Drivers.

They are not ten formulas for improving cash flow. They are not ten numbers that should always move in a particular direction. And they are certainly not ten independent levers that management should optimize without considering the rest of the business.

They are something much more practical.

They are ten places to look when you want to understand what happened to cash.

1. Growth

Growth affects cash flow because additional business often requires resources before the resulting cash is collected.

A growing product company may need more inventory, additional employees, greater production capacity, increased freight, larger receivables, new equipment, or additional warehouse space. Some of those requirements may arise well before the company receives cash from the additional sales.

That doesn't make growth undesirable. As we discussed in the previous Executive Insight, profitable growth can be an excellent use of financial resources.

The management question is whether the company understands what the growth requires.

When growth changes materially, ask: What additional commitments are being created? How much working capital is required? Does existing capacity support the growth? When should the additional cash begin returning to the business?

Growth tells management where to look.

It doesn't tell management whether to grow.

2. Pricing

Pricing can have a powerful effect on both profitability and cash generation because price influences the economics of every transaction.

But pricing decisions rarely occur only at the published price-list level. They also occur through discounts, rebates, promotional programs, customer-specific arrangements, freight allowances, volume incentives, and exceptions negotiated during the sales process.

A company may therefore maintain its official prices while its realized pricing gradually changes.

That is why a margin decline should not automatically produce the instruction, “Raise prices.” Management first needs to understand what happened.

Did input costs increase faster than prices? Did product mix change? Did discounting increase? Did competitive conditions change? Did a major customer's economics change?

Pricing is a Cash Flow Driver because decisions about what customers actually pay eventually become financial results.

The number tells you something changed.

Management still has to understand why.

3. Cost of Goods Sold

For a product business, the costs required to produce or acquire what it sells are central to its economics.

Material costs can change. Supplier pricing can change. Freight can change. Labor efficiency can change. Production yields can change. Product mix can change.

Purchasing decisions can affect unit costs. Manufacturing inefficiencies can create additional costs that are not immediately obvious.

A change in gross margin may therefore originate in several different places.

Again, the objective is not simply to demand lower costs. A lower-cost supplier that creates quality or delivery problems may ultimately be far more expensive. Reducing production labor indiscriminately may create bottlenecks, overtime, or service problems.

Cost of Goods Sold is a place to investigate the financial consequence of operating decisions.

The management question is not simply, “Can we spend less?”

It is, “What is happening to the economics of what we sell, and why?”

4. Operating Expenses

Operating expenses represent another broad collection of management decisions.

People are hired. Software is added. Professional services are engaged. Marketing programs are launched. Insurance changes. Facilities expand. Administrative resources grow. New capabilities are developed.

Some expenses support current operations. Others are investments in future capability.

Some remain valuable for years. Others continue long after their original purpose has disappeared.

A company can therefore experience rising operating expenses without anyone ever making one large decision to increase overhead.

As we discussed in Executive Insight #020, smaller recurring commitments can accumulate.

The management opportunity is not indiscriminate cost cutting. It is understanding what the company is spending, why it is spending it, whether those commitments still support the business, and whether expenses are developing in a way management intended.

5. Inventory

Inventory is cash in another form.

For manufacturers, distributors, wholesalers, and other product businesses, inventory is necessary. Customers expect products to be available. Production requires raw materials. Supply-chain uncertainty may require safety stock. Seasonal businesses may need inventory well before sales occur.

The goal therefore cannot simply be to minimize inventory.

Too little inventory can damage customer service, interrupt production, create expedited freight, and cost the company profitable sales.

Too much inventory can tie up substantial cash, consume warehouse space, increase carrying costs, and create exposure to obsolescence.

The management question is whether the inventory investment makes sense for the business.

If inventory increases materially, ask why. Is it supporting growth? Preparing for seasonality? Protecting against supplier risk? Accumulating because demand slowed? Increasing because purchasing quantities are too large? Building because production and sales are no longer aligned?

Inventory is the number.

The operating decisions behind it are the story.

6. Receivables

A sale does not necessarily create cash.

For companies selling on credit, the sale creates a receivable first. The cash arrives later.

That timing makes receivables one of the most visible connections between commercial decisions and cash flow.

Customer terms matter. Billing speed matters. Billing accuracy matters. Collection discipline matters. Customer quality matters. Disputes matter. Sales growth matters.

If receivables increase, the explanation may be slower collections. But it could also be rapid recent growth, longer negotiated terms, changing customer mix, billing problems, or several factors operating simultaneously.

That is why receivables are not simply a Finance responsibility.

Sales decisions can affect them before Finance ever sees the invoice.

Understanding receivables means understanding the complete process that begins with the customer relationship and ends when the cash arrives.

7. Accounts Payable

Accounts payable works in the opposite direction.

Suppliers may provide the business with time between receiving goods or services and paying for them. That supplier financing can be an important part of the company's working-capital structure.

But extending payables is not automatically an improvement.

A business can preserve cash temporarily by paying suppliers more slowly. If doing so violates agreed terms, damages supplier relationships, eliminates discounts, restricts future supply, or signals financial distress, the short-term cash benefit may create larger problems.

On the other hand, a company may discover that it routinely pays faster than required without receiving any economic benefit.

The important issue is not simply whether payable days should be higher or lower.

It is whether the company's payment practices, supplier terms, and purchasing relationships are being managed deliberately.

Once again, the driver provides a place to investigate.

It does not provide the decision.

8. Capital Expenditures

Capital expenditures can consume substantial cash quickly.

Equipment, vehicles, facilities, technology, tooling, and other long-term assets may require significant financial commitments. Yet those investments can also increase capacity, improve efficiency, reduce costs, strengthen quality, or support future growth.

That is why capital spending illustrates so clearly why cash flow cannot be managed by simply minimizing cash outflows.

A major capital expenditure may be one of the best decisions a company makes.

Or it may create years of financial obligations for capacity the business never needed.

Management has to evaluate the investment in context:

What problem are we solving?

What capability are we creating?

What alternatives exist?

What cash will be required?

When should the economic benefit appear?

How will the investment be financed?

The cash outflow is important.

The purpose of the investment is more important.

9. Debt

Debt changes the timing of cash.

Borrowing provides cash today and creates obligations tomorrow. Repaying principal consumes cash today and reduces future obligations.

Neither direction is automatically good or bad.

Debt can finance productive assets, working capital, acquisitions, growth, or temporary operating requirements. It can also mask an underlying business that is consistently consuming more cash than it generates.

That is why I do not treat debt as though it were simply another source of operating cash flow.

If borrowing increased, management should understand why it was required and what the borrowed funds supported.

Was debt financing growth? Equipment? Working capital? An acquisition? Owner distributions? Operating losses?

The change in debt is visible.

The reason for the change tells management much more.

10. Owner Distributions

Owner distributions are sometimes treated as though they exist outside the operating discussion.

They don't.

For an owner-led business, decisions about how much cash remains inside the company and how much moves outside it can have a significant effect on financial flexibility.

Owners have legitimate reasons to take distributions. The business exists in part to create economic value for its owners. Taxes may need to be paid. Personal financial objectives matter. Building wealth outside the company can be an important objective of ownership.

The issue is not whether owners should take distributions.

It is whether the decision is being made with an understanding of what the business needs to support operations, investment, growth, debt obligations, and reasonable financial reserves.

A distribution creates value for the owner outside the company.

It also reduces the financial capacity remaining inside it.

That is a tradeoff worth making deliberately.

The Drivers Are Connected

The ten drivers are presented separately because doing so makes them easier to examine.

The business does not operate that way.

Growth can increase inventory and receivables. Pricing can affect volume and margin.

Purchasing decisions can affect both Cost of Goods Sold and inventory. Capital expenditures can affect debt. Growth can increase operating expenses before revenue catches up. Owner distributions can affect the company's ability to finance working capital internally.

One decision may therefore influence several drivers at the same time.

That is why optimizing each driver independently can produce poor decisions.

Aggressively reduce inventory and customer service may deteriorate. Push pricing too far and profitable volume may disappear. Delay supplier payments excessively and an important relationship may suffer. Eliminate operating expenses indiscriminately and the company may remove capabilities it needs.

The purpose of the Ten Cash Flow Drivers is not to tell management to maximize or minimize each number.

The purpose is to help management understand the system.

Executive Reflection

At your next financial review, start with the cash-flow result and work backward through the ten drivers.

Which drivers changed materially?

Then ask what happened inside the business.

Did growth accelerate?

Did realized pricing change?

What happened to product costs?

Which operating expenses changed?

Why did inventory move?

What happened to receivables and customer terms?

Did supplier payment patterns change?

What capital investments were made?

Why did debt change? What distributions occurred?

You probably won't find the answer in all ten places.

You don't need to.

The value of the framework is that it gives management a disciplined way to narrow the investigation.

Instead of asking the broad question, “Where did all the cash go?”, you begin asking specific questions about the parts of the business that created the financial result.

That is a much more manageable conversation.

The BusinessWiser™ Perspective

The Ten Cash Flow Drivers sit at the center of the first half of the Dynamic Duo because they connect two things owners often see separately:

Business decisions and financial results.

Growth, Pricing, Cost of Goods Sold, Operating Expenses, Inventory, Receivables, Accounts Payable, Capital Expenditures, Debt, and Owner Distributions provide practical places to investigate how decisions throughout the business ultimately become visible in cash flow.

They are not prescriptions. They are not formulas. And they are not an instruction to squeeze every possible dollar of cash out of every part of the company.

Businesses require judgment.

Inventory may need to increase. A customer may deserve longer terms. An investment may consume cash. Debt may be appropriate. An owner distribution may make sense.

The important question is whether management understands the financial consequence of those decisions and how they interact with the rest of the business.

That is what the Ten Cash Flow Drivers are designed to make more visible.

And once those connections become clearer, management can begin moving from the question that has guided the first part of this series—

What decisions created the cash flow we're experiencing today?

—to the question that completes the Decision Problem:

What decisions are we making today that are creating tomorrow's cash flow?

That is where we go next.

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 #023 — Ten Places Where Decisions Become Cash Flow

Final Thought

Cash flow can appear complicated because the result reflects activity from across the entire business.

The Ten Cash Flow Drivers make that complexity easier to investigate.

They give management ten places to look.

Not ten automatic answers.

Not ten numbers to optimize independently.

Ten places to begin asking better questions about what changed, why it changed, and which decisions contributed to the result.

The drivers don't make the decision for you. They help you see the decisions that are already becoming cash flow.