Warning Signs Your Dividend Is About To Be Cut

Last weekend, I was talking to a buddy who started a new business. I asked him how it was going.

“Sales are going great. But I have a cash flow problem. I have to turn away orders,” he said, shaking his head.

He explained that he can’t fulfill orders until he gets paid on older ones that have 30-day terms. And if his customers are late paying the bills, he’s really stuck.

Let’s say my friend has $1,000 in cash in the bank. On July 1, he gets an order that will cost him $1,000 to fill. He spends the $1,000, charges his customer $2,000 and is paid on August 1.

Also on August 1, he gets an order for another $1,000 worth of product ($2,000 in revenue) and fills the order, leaving him with $1,000 in cash.

On August 20, he gets a $4,000 order that will cost him $2,000. But he has only $1,000 that he can use to buy the product that he’s going to resell. He can either borrow money or refuse the order.

You can see from this simple example how cash flow is the lifeblood of a business. If he doesn’t have enough cash coming in, he can’t buy enough product to make future sales.

As an investor, you also should care deeply about cash flow. Here’s why…

Let’s use the above example and pretend my friend is a publicly traded company.

The company fills the $4,000 order on which it’s supposed to get paid on September 20. But the customer is late, and as of September 30, the company has not received payment. Its books close for the quarter on the 30th, and it reports results.

It booked $8,000 in revenue – a $2,000 order on July 1, another $2,000 order on August 1 and $4,000 on August 20. Its quarterly report will show $8,000 in sales.

We know its cost of goods sold is 50% of its revenue. Let’s assume it spends another $1,000 on sales, general and administrative. The company’s profit is $3,000

But its cash flow tells a different story. Because cash flow shows investors how much cash came in the door or went out. Remember, the company is still owed $4,000 from that August 20 order.