Reasons Why Your Business May Be Struggling with Cash Flow & How to Solve It
One of the most critical parts of developing a strong business is having a decent cash flow. Cash flow issues are frequently mentioned as a primary cause of small business failure. There's no arguing that cash flow management is critical, and thus, it shouldn't be overlooked.
When you're beginning a business, it's critical to avoid and resolve cash flow issues—getting off on the wrong foot can be tough to overcome. Even if you've been in the company for a while, it's critical to monitor your cash flow situation regularly and correct course to avoid any complications.
A company's cash flow is its lifeblood. Every successful business needs a consistent revenue stream and cash on hand to pay bills and make payroll. Unfortunately, many business owners have cash flow issues, and it's often through no fault of their own, but knowing how to deal with the things preventing the flow is critical.
What exactly are cash flow issues?
When a company doesn't have enough liquid cash to meet its liabilities, it runs into cash flow issues. Businesses may struggle to pay debts and other obligations if cash outflows exceed cash inflows.
Net cash outflows may not always imply that a company is experiencing cash flow problems. When making substantial payments or dealing with cyclical economic changes, it's usual for businesses to face a net cash outflow. When outflows surpass inflows, cash flow becomes an issue. At that moment, the company has depleted its financial reserves and cannot pay its obligations.
If you have a business, it is only prudent that you know why some companies struggle with cash flow before you and your business experience the same.
Low-profit margins or a sluggish business.
One of the most common reasons for cash flow issues is poor profit margins. Although cash flow and profit are not the same things, a company's net profit directly influences cash flow. A high income merely implies the business has more cash flow, whereas a low income means less cash flow.
However, a corporation may be profitable for some time but still have cash flow problems, and it is due to the accrual foundation of accounting, which records revenues and costs as they are incurred rather than as they are received.
Profitable businesses guarantee that they have enough cash to meet their bills. Still, they also allow themselves to reinvest, develop their products and services, and even take on additional credit or loans. Compared to a business with lesser earnings and trying to make ends meet, profitable businesses have increased cash inflow.
Inadequate financial planning.
There's a saying that if you fail to prepare, you're preparing to fail. The lack of a disciplined approach to financial planning is a persistent cause of cash flow issues for many small businesses. Working with a clear forecast, financial plan, and budget – and reviewing and updating these key papers regularly – will allow you to anticipate any possible cash flow issues and take steps to mitigate them. It might involve having a ready-to-implement plan for obtaining more financing if necessary.
Expenses are not being paid attention to.
Unexpected costs or too much money flowing out each month put many businesses in a cash flow pinch (such as ongoing expenses that have quietly crept up to an unsustainable level). Resolving a cash flow issue necessitates a fresh, thorough examination of the company's continuing cost structure.
Every business owner should follow a strict procedure for tracking monthly spending and forecasting future expenses for the months ahead. A qualified business accountant can help you keep an eye on the overall health of your company's cash flow so you can make smarter decisions.
Expanding too quickly.
Expansion of your business too quickly, without a solid plan or sufficient funds, might result in a loss. For example, if you try to open a second bakery location before your present one starts to make a profit, or if you start paying rent in advance for new warehouse space you aren't ready for, cash flow will rapidly become an issue.
Expansion too soon might also entail a rapid growth of your present business. When things are going well, it's tempting to raise your retail orders even if you don't have the means to fulfill them, but keep in mind that this will negatively influence your cash flow.
When it comes to past-due receivables, you can't be too kind.
We understand how difficult it can be to build strong client connections, particularly as a small business servicing a local community. You want to provide loyal consumers with exceptional service and payment choices, and you put yourself at a cash flow disadvantage if you allow past-due receivable bills to run too far past the due date.
Allowing consumers to postpone payment for your services benefits neither you nor them. It may harm employees, and your ability to supply services to new consumers may be contingent on prompt payment from those who owe money. Maintain positive cash flow by enforcing strict due dates and penalties for late payments.
Insufficient cash reserves.
In a 2020 Federal Reserve Banks study, 86% of small company owners stated they'd need to act if faced with a two-month income shortfall. One-seventh of them claimed they'd have to shut down their businesses.
To prevent a cash flow problem, most organizations should have enough cash to cover up to six months of costs if income drops. However, the easiest approach to figure out how much money you should set aside is to make a cash flow prediction.
The cash flow statement is not used.
Some tools and reports can assist business owners in understanding and managing their financial situations. In addition to the balance sheet and income statement, the cash flow statement helps managers make educated decisions to optimize a business's cash.
The cash flow statement is used to map and forecast cash flow. It can track when and how much money will move in and out of a company. This financial statement assesses the company's present cash situation while also forecasting future cash transactions.
The cash flow statement also aids owners in identifying their primary cash sources. Because cash is classified as operational, financing, or investment activities on the cash flow statement, an owner may focus on various activities to enhance cash flow.
Forecasting or accounting techniques that are inaccurate.
Keeping track of a company's cash flow and forecasting sales may be straightforward. However, the owner may find that cash management gets more complicated when a business expands.
According to the 2020 QuickBooks State of Payments study, 61% of small business owners have no idea how much they spend each month. Sixty-two percent stated they don't know how much money they have in their bank accounts each month.
You have choices if you're having trouble managing your financial flow. Consider employing a bookkeeper or improving your accounting system and cash flow instruments.
Operating as a sole proprietorship or sole trader.
According to the SBA, 70% of small business owners are sole proprietorships or sole traders, making it more difficult to obtain loans and investments.
However, each business structure has its own set of benefits and drawbacks. Only a tax or legal specialist can tell you which one is best for you; therefore, you should always get specialized expert guidance before making any business choices.
During the off-season for their enterprises, even the most successful businesses endure poor cash flow. Knowing when your off-season is and planning for it will help you manage your business cash flow.
Consider purchasing working capital solutions before pouring too much of your own money into your businesses during a sluggish month (or several months) to stay afloat. A company cash advance or line of credit might assist preserve personal assets while keeping you in business until sales improve.
How to Solve Cash Problems
Make a budget for cash flow.
A cash flow budget or projection estimates how much money will flow in and out of your organization over a specified period. You'll be able to identify which months you may expect a cash shortfall and which months you can expect a surplus by establishing this. You'll also obtain a fair estimate of how much cash your company will need to stay afloat over the next year or two.
A cash flow projection may also assist you in making key decisions, such as whether to make capital investments or whether or not to reduce an expense.
Use a line of credit for your small business.
A small company line of credit functions similarly to a credit card in that borrowers pay interest only on the outstanding balance, not on the whole credit line. When company owners pay off their outstanding debt, the credit available to borrow is replenished. Interest rates are frequently lower, particularly for companies with strong credit.
Make a business survival plan.
Break out your business plan's procedures, operations, income, and costs. Review your company's profit and loss statements and margins using task costing if appropriate. Identify the items, services, clients, and labor that account for the lion's share of costs and revenues. The idea is to keep the doors open by slowing down and scaling back.
Under normal conditions, making this information available can provide you with an accurate cash flow prediction. It can also help you estimate how scaling back will influence your businesses in unusual circumstances.
Make any necessary adjustments to your inventory.
Examine your inventory to find out which things aren't selling well. These items deplete your cash flow since the money you spend on them isn't being converted into sales and hence income. You may alleviate this cash flow issue by selling these less commonly purchased things at a discount and without purchasing further stock after depleting the current inventory. Similarly, you may always put extra money into stocking up on popular items.
Re-examine your company's operations.
To improve cash flow, review your cost structure regularly to identify inefficiencies and initiatives that can be tweaked to save money. There are parts of the business that can be outsourced to freelancers and third-party companies. This will allow you to do the task without paying a wage or providing benefits. During quiet periods, it is also recommended that employers reduce part-time staffing.
Your company strategy will vary as the economy changes. Always be on the lookout for opportunities to improve your product and make wiser investments.
Work out favorable credit terms with your vendors.
You might also try negotiating better payment conditions with your business partners or suppliers.
You'll have a 30-day period when you've paid more money out than you've recouped if your consumers pay you within 60 days of a product or service being provided, but you pay your suppliers within 30 days. This can easily result in a cash flow shortage if not prepared for.
Your suppliers may be willing to extend your payment terms if you have an excellent payment history. That way, you'll be able to keep the money for an extended period and lessen the chances of being out of pocket. Rather than not receiving a payment, most suppliers would prefer to give better payment terms.
Reorganize your receivables management.
When a new company makes a big sale, it doesn't always indicate cash-flowing. Some companies will only receive a small up-front payment if they provide long-term payment plans, depending on the form of the transaction.
A good receivables management strategy, on the other hand, may help enhance cash flow. In this context, one tactic used by property sellers is to entice buyers to make larger down payments, and offering discounts for more significant first payments is one effective strategy. Customers may be more willing to pay extra up-front for goods or services due to this.
It's also a good idea to provide early payment discounts, and this allows business owners to budget more efficiently and reduce the likelihood of consumers missing payments.
Make business development a never-ending cycle.
Marketing and company growth plays a critical role in ensuring a steady and sustainable cash flow. Many project-based and seasonal enterprises may be familiar with the feast and famine cycle. They get a huge contract and get monthly payments for six, twelve, or eighteen months, but after the last invoice is paid, they have no immediate source of revenue.
It's critical to sustain your marketing and company development activities even during your busiest times. This will help you cut the time you're without a significant income stream and avoid the cash flow troubles that come with it.
A consistent cash flow is important for a business to thrive. As mentioned, cash flow is the lifeblood of a business. Without it, a business may fall into ruin, but cash flow problems can be easily solved. Having reliable records of transactions can help a business to monitor and maintain its cash flow.
At Profit bank, we offer free bookkeeping services to small businesses. We keep your income statement, balance sheet, and cash flow statement updated and accessible. Our free banking and bookkeeping services will help you maintain your business’ cash flow and avoid any future problems.