If you’re a business owner, it won’t have taken long for you to appreciate why there is so much talk about the importance of cash flow in any business start-up books you may have read.
You’ll have found that it is easy to spend money but much more difficult to make sales and to collect the cash when it’s due to be paid.
In this article I’m going to look at:
- How businesses get into cashflow difficulties
- How cashflow problems can be fixed
What Are The Causes Of Cash Flow Problems In Business
Businesses often start with cash flow issues from Day 1 because, to use a financial term, they are under-capitalised.
The business owner hasn’t invested enough money in the business to get it started comfortably so that the initial start-up costs can be paid together with funding to support the normal working capital cycle of spending money on stock / inventory before cash is collected from sales made on credit.
To add to this initial start-up cash problem, the business owner may expect to earn a salary either right from the start or within two or three months of starting. Unless the business gets off to a flying start, it is unlikely that it can generate the cash to cover these costs from normal trading.
The cash problem is made worse by bad cash habits.
You need to be thinking about the cash consequences of all your decisions.
The credit terms that you agree with customers and suppliers will have a major effect on how much cash is needed to fund your business. Any inequalities in your business model – paying on 7 days, collecting cash on 90 days – will get worse as your business grows.
You have some excuse on these payment terms because it comes down to bargaining power and the willingness to walk away from any deal that doesn’t suit you. New businesses or struggling businesses have few other options and therefore have limited negotiating strength.
Much worse is when the damage is self-inflicted by:
- Paying suppliers before the money is due because it keeps your books straight.
- Not invoicing customers as soon as the goods are delivered or the service is completed. (You may even be able to get payments in advance.)
- Not chasing your debtors /accounts receivable when they are due.
Another source of cash shortages are bad decisions. Business start-ups which start off with a plentiful supply of cash can be prone to these mistakes.
Do you remember the Internet boom in 1999 and the collapse in 2000?
It was thought that any kind of business could become rich on the Internet and investment firms were dishing out easy money. This created a feeling of well-being that allowed the businesses to live extravagantly. The websites were more expensive and much fancier than needed. Large fortunes were wasted on advertising that promoted the website address (to build brand awareness) without creating any kind of brand positioning. The businesses hired staff like crazy and occupied fancy offices.
Most new businesses don’t have millions to burn but it is easy to convince yourself that you need many things you don’t.
Profit does not equal cash flow. A business can be profitable and have a bad cash flow. Or it can generate cash while losing money. In the short term. Ultimately profit and cash are connected so profitability problems will cause cash problems.
A business can have very lean operations but if it struggles to attract leads and it doesn’t make enough profitable sales with good margins, accumulated losses will eat up the bank balance.
A more established and stable business can have cash flow problems, even while it is trading profitably if it forgets a predictable but occasional payment (e.g. tax on the profits of the business or the director bonuses or dividends). Things look OK and all of a sudden the business needs to pay out money it doesn’t have.
A more regular problem that is similar is the rental payments. This is a big problem for retail chains since huge payments have to be made on the quarter days of March, June, September and December. You will see retailers go into an insolvency procedure just before a payment is due.
The cash shortage can also arise from a large bad debt. Cash crises can be transferred from one business to another by the failure to pay. This can be temporary while a large account delays its normal payment or can become permanent if the business is bankrupt. Often there are early warning signs where a large customer pays later in the month and clears a small amount of the balance. Sometimes the first you hear about it is when you receive a letter from an insolvency practitioner.
How To Solve A Cash Flow Problem
A great way to get past a cash flow problem is to work with a cash flow coach like me.
Together we will tackle the issues you face and you’ll learn how to stop these things going wrong again in future, or if they do happen through no fault of your own, how to correct them.
Two things are top priority:
- Do a cash flow forecast so you can understand the extent of the problem over the next few months. I recommend a 13 week receipts and payments forecast that is updated weekly. I know it’s a boring and predictable answer but you need to understand the extent of the problem so you can think through longer term solutions rather than fire-fighting week to week.
- Improve your sales invoicing and credit control procedures. You need to identify and correct bad habits and take proactive steps to collect the money you are owed.
You need to build up a cash buffer in your business to take away some of the day to day pressures of managing your cash within any overdraft limit. When you’re in a cash crisis, it takes precedence over everything else and it’s hard to take the longer term steps needed to improve your business.
An obvious answer is to get a bigger facility from the bank. This is not usually a good idea and because bankers don’t see their role as papering over the cracks, it is often hard to do.
A better solution is to get a cash injection. This may come from:
- You as the business owner
- A new investor (although your basic business will need to be attractive)
- A boost in trading that is quickly cash positive.
The cash forecast should help eliminate bad cash decisions because you can see the problem. You will know that you can’t afford to take a big bonus or to buy a new car or some capital expenditure for the business.
It will also focus attention of any purchasing you do for stock.
Some business owners take pride in having a wide selection to offer customers including the latest, most innovative products.
Others love a bargain and find it difficult to resist bulk discounts offered by suppliers.
Both of these are cash flow killers. While you can see the physical stock, you may not appreciate how much money is tied up.
Longer term, the answer to cash flow problems is to increase the profitability of the business.
My cash flow coaching service roles into elements of my Quick Profit Coaching and USP Coaching.
Improving profitability will take pressure off your cash position and allow you to afford the little luxuries.
This requires an understanding of the cost volume profit relationship.
The Consequences Are High
Businesses go bankrupt for one reason.
They run out of money and are no longer able to pay employees and suppliers.
A cash problem indicates that you need to take urgent action, either on your own or working with a business coach.
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