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Cash flow problems can be devastating to your business if not resolved promptly. Discover why they happen, how to identify them and what to do to resolve them.
Companies fail for many reasons, and yet, year after year, one key reason tops the list — a lack of cash flow. Cash flow refers to the amount of cash that comes in and goes out of your business. For example, a sale is a cash inflow while paying business expenses is a cash outflow. Understanding your cash flow is an important part of managing your business effectively. A positive cash flow enables you to pay your expenses on time and seize opportunities to expand your operations or invest resources back into your business.
Proper cash flow management is critical to the long-term success of a business, but it can be one of the biggest challenges small and mid-sized business owners face. It’s not uncommon for businesses to encounter cash flow problems at one time or another. Fortunately, most of these problems can be prevented or resolved with the right strategies and processes.
In this post, we’ll explore how cash flow issues can impact your business. We’ll look at the causes of low cash flow, common warning signs and tips to help you resolve cash flow issues quickly.
Cash flow problems occur when a business does not have enough cash on hand to cover its liabilities. When cash outflows exceed cash inflows, businesses may struggle to pay debts, employees, suppliers and other expenses. Occasionally cash flow issues arise because of an unavoidable emergency expense. However, more often there are signs on the horizon. Here are a few to look for:
Sales are high but working capital is low.
Business growth is stalled.
Outstanding invoices are accumulating.
Businesses can experience gaps in cash flow for many different reasons. Here are some of the most common causes of cash flow issues and ways you can solve them.
As a business grows, cash flow management can become increasingly complex. Inadequate financial planning, whether in the form of disorganized or nonexistent bookkeeping or a lack of budgeting, can mean you do not have the cash you need to pay the bills.
Here’s what you can do about it:
Learn how to forecast cash flow. A cash flow forecast is an estimate of how much money you expect to see moving in and out of your business during a specific period. If you create a forecast, you’ll be able to see when to expect a cash deficit and when to expect a surplus. Proactive financial planning and forecasting can also help you spot potential cash flow problems before they arise.
Know your cash flow position. It is imperative that you understand your cash flow statement and know your cash position at all times. A company’s cash position refers specifically to its level of cash compared to its pending expenses and liabilities. To understand your cash position, you’ll need to calculate your cash inflows (all forms of money coming in to your business) minus your cash outflows (all money going out of your business). This will let you determine whether your cash position is positive, negative or neutral. Most business accounting software providers, such as QuickBooks, Xero and FreshBooks, offer cash flow statement tools.
Understand your cash conversion cycle. The cash conversion cycle (CCC), also known as the net operating cycle, is an important metric for you to measure and understand. It can be used to evaluate the efficiency of your company’s operations and management. Specifically, it’s a measure of how long it takes to convert investments in inventory and other resources into cash flow from sales. A simple way of thinking about the CCC is through this mathematical formula:
CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)
Late-paid invoices, or accounts receivable, are a common cause of cash flow problems. Small business owners typically operate with tight budgets and rely on prompt payment from their clients to pay bills as well as maintain or scale their businesses.
To resolve this issue, start by familiarizing yourself with billing best practices that save time and improve cash flow. You might decide, for example, to offer electronic payment options, change your payment terms or leverage an early payment program to accelerate your invoice payments. Early payment platforms like C2FO’s can help you to reduce DSO and improve your working capital without taking on new debt.
The more inventory you purchase, the more working capital you have tied up in unsold products. This can take a significant toll on your cash flow. Overinvesting in inventory can leave you in a bind if the products aren’t selling or are selling too slowly to cover your investment costs.
Consider using an inventory management system to track and balance your inventory. Monitoring inventory can help you avoid overstocking or running out of key items. Keeping inventory on hand for the shortest time possible (reducing DIO in the cash conversion cycle) can help you ensure inventory doesn’t contribute to cash flow shortages.
Providing too many discounts or selling products and services at an insufficient price point can result in low or negative gross margins. Poor margins, whether due to competitive or manufacturing pressures, will negatively impact your gross income and your cash flow, especially if your operating costs remain unchanged.
To fix this issue, you should review costs, conduct market research and create a well-thought-out pricing strategy. Regularly reviewing your cost of goods sold (COGS), pricing points and expenses can help you determine if you should adjust prices or discontinue products or services with weak margins.
Overhead expenses are costs associated with running a business that are not directly tied to selling a product or service: for example, the costs of renting equipment and paying for utilities. Sometimes these expenses can be too high relative to the revenue your business is generating, and that can affect your cash flow.
To avoid this scenario, audit your business expenses regularly and cut costs where you can without compromising operations. For expenses you’re unable to eliminate, such as your internet service, for example, it may be worthwhile to investigate cheaper providers.
Having an inadequate supply of funds saved in the event of an emergency, or worse, no cash reserves at all, can leave you unprepared to handle unexpected circumstances and can quickly lead to a cash flow crunch.
If and when your financial circumstances allow, you should work toward creating a cash buffer. Try to build a reserve sufficient to cover a few months of business expenses. If you have developed a cash flow forecast, you can use it to determine the amount of reserve cash you should have on hand.
When your business is experiencing rapid growth, you are often faced with additional expenses to ramp up your business’s infrastructure — such as technology, inventory or equipment. In this scenario, cash flow shortages can occur when expenses exceed working capital. For example, perhaps a new contract requires you to expand production, but doing that requires significant upfront investment before receiving any return in sales revenue.
If your business is in a high-growth period, it’s important to familiarize yourself with working capital management practices. To maintain efficient operations and sufficient cash on hand, anticipate and prepare for cash flow shortfalls with a realistic plan that accounts for delays in the collection of receivables.
Striking the perfect balance between income and expenses at all times is a complex equation for any business. Cash flow issues can be scary, but it’s important to remember there are solutions you can leverage to overcome them. If you are proactive and keep a constant eye on the cash flow needs of your business, then you’re on the right track. Hopefully, awareness of common signs, causes and solutions to cash flow problems, such as those outlined here, will help you navigate similar challenges.
Are you interested in increasing cash flow without taking on new debt? Learn more about C2FO’s Early Payment platform.
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