It is common for businesses to experience cash flow problems, especially during a recession. In fact, even when sales are soaring, it is possible for companies to have difficulty managing cash. How can you improve your cash flow management to eliminate such cash flow problems?
A good cash flow control is important in building a healthy business. You need to know where your money is going in order to keep your company going in the right direction. Whenever there are cash flow problems, the best way to eliminate them is to identify the cause of the problem.
We made a list of common cash flow problems and how you could fix them.
Underestimating startup costs
If you are just starting your business, one of the most common mistakes you would want to avoid is underestimating startup costs. It is prudent to have a realistic budget with room for overage. This helps you avoid cash flow problems right off the bat and ensure that you get a good start to your business.
Unrealistic estimates and lack of a cash buffer is very challenging to correct when you are just starting your business venture. If you are unsure of your budget or don’t know where to start, getting help from a financial advisor is recommended.
2. Expecting profitability too quickly
Another unrealistic expectation from new business owners is reaching profitability quickly. Studies show that a majority of small business owners reach profitability within the first four years of their business, but only two-thirds of them can do it within a year.
As entrepreneurs, in order to have good cash flow with your startup, you need to keep two things in mind: have a realistic budget, and be prepared to wait more or less four years before gaining profit. Setting a realistic time frame for profitability and having enough cash reserves to support you until then can help you avoid cash flow issues.
3. Poor financial planning
Preparing a good cash flow forecast or budget is important. Failure to do so can lead to a shortage of cash. Aside from a great cash flow forecast, you also need to make sure your business isn’t following a negative cash flow business model. When you give payment terms to your customers, make sure you can collect their payments before your bills arrive.
Set up your balance sheets, profit and loss statements, cash flow statements, and forecasts. This may sound daunting, but there are a lot of templates and tools available online to help you with this. Moreover, if you want accurate plans and forecasts, getting a professional accountant is advised. Their expertise can help you set up a system for financial reporting and provide guidance in your strategies and other financial aspects.
4. Overlooking high overhead costs
Overhead costs are regular business expenses that aren’t directly involved in the production and sales of your products. Examples of overheads are rent, utility bills, and the Internet.
These costs are important to keep your business running. However, because they aren’t involved in generating revenue, they can really hurt your cash flow, especially when the expenses get too high.
Regularly tracking and reviewing your overhead expenses help you identify which ones your business really needs and which ones you can cut down. You can also try looking for cheaper alternatives, like a different service provider or a smaller space with cheaper rent.
5. Late or partial outstanding payments
Your business might be selling like crazy, but it can become quite a problem if your customers are always late in paying you. Not only are you out the profit, but you’re also out the cost needed to complete the product or service. Collecting payments too slowly can stifle your business’s growth and might even cause you to be behind in paying your bills.
Offering partial payments or instalments is a smart strategy in driving sales, but it also hurts your cash flow.
Make sure you have a proper receivables collection in place. Pleasing your customers is important, but being too lenient in their payment will only harm your business.
You can also opt to get paid upfront or be given a deposit. Make sure you send your invoices ASAP and even implement automated payment reminders on them. Another good strategy is incentivizing prompt and full payments by offering discounts for early payments and payments made in full while charging a fee for late payments.
6. Expanding the business too quickly
Every small business owner hopes to expand its business. However, expanding too soon or too fast, especially without a concrete plan or sufficient money, can cause cash flow problems.
If you did bite off more than you could chew, a way to fix this problem is to get a line credit from the bank, like an overdraft or a short-term loan.
However, the best way to avoid this cash flow problem is to maintain a disciplined spending plan and having reserved cash for unexpected costs or emergencies. You could also generate some streams of passive income to fund some of your business growth. Just make sure you have identified your business goals and determined your needs to get there.
7. Low profit margins
Your profit is your major source of cash. Revenues generated by your business are converted to cash upon collection. This is then used to sustain production, pay necessary expenses, and be utilized further along the way to expand the business.
If your profit margin is low, you won’t have enough money on hand to cover all your outflows. This could lead to debts or, worse, bankruptcy.
Low profit margins can be traced to several factors: incorrect product pricing, ineffective marketing, low sales, low productivity, or too high or uncontrolled spending. Improving these factors can improve your profit margin.
A strong and sustainable profit plan helps improve your cash flow issues. Review your profit plan regularly and keep track of it over time to gain insight into your pricing and spending. This also helps you identify what changes (in pricing or spending) you need to implement.
8. Insufficient cash buffer on hand
A cash buffer serves as a safety net for your business. Emergencies and unexpected expenses happen, but having reserved cash on hand can cushion the blow of such events. Having none prepared can put a strain on your cash flow.
In order to determine how much cash buffer your business needs, divide cash balances by cash outflows. This tells you how many days your cash on hand can cover your expenses when there are no incoming funds.
An average small business has 27 days of cash buffer readily available. You can adjust this depending on the nature and needs of your business.
9. Disorganized accounting
A lot of people, even entrepreneurs, can struggle with numbers. However, disorganized accounting can spell trouble for your business. This could lead to a loss in productivity, as you are in the dark about the state of your business finances.
Tracking, budgeting, planning, and forecasting are important, but they could do more harm than good if not done right. If you aren’t good with numbers or are not confident in your accounting, hiring an expert is a good investment for your business.
10. Sales challenges
When your expenses are wisely controlled but sales did not reach the quota you set or expected, cash inflow slows down, making your cash flow suffer.
Sometimes, such declines in sales are caused by external factors like market fluctuations, weather, or the COVID-19 pandemic. Other times, it is an internal issue. You might need to revamp your marketing strategy or optimize lead nurturing. Whatever the case may be, improving your sales ASAP is the key to solving the problem.
Some strategies that work for a lot of businesses are running a flash sale, rebranding, and adjusting marketing strategies.
In business, you need to spend money in order to make money. However, sometimes business owners fail to see that they are spending too much. It could be from expensive overheads or unnecessary expenses. Whenever your business spending gets out of hand, it is time to revisit your budget and identify what needs to go.
Some budget tips for business owners:
- Automate repetitive tasks that you previously hired people to do.
- Layout your business plan and financial milestones before making different investments.
- Monitor and categorize your expenses and figure out alternatives to reduce the highest costs.
- Go paperless. Paper is an expense most businesses can do without. Save money, save your business, and save the trees.
- Only invest in equipment or systems necessary for your business.
When your business yields negative cash flow, check your inventory. Having safety stock is important, especially in retail, as it can be costly to run out of stock. However, overstocking has a negative impact on the movement of cash in and out of your business. Aside from paying your supplier, you also have holding costs for warehouse space.
Improve your inventory management by identifying your business’s ideal safety stock level. Implement auto-reorder and purchase order processing. Lastly, you can invest in an inventory management system to help in inventory forecasting.
All in all, they say prevention is better than cure. Catching factors that might cause cash flow problems ahead of time is the best way to get rid of them. Of course, there are things you cannot foresee or expect no matter how vigilant you might be, and a small strain in your cash flow here and there is normal. Just make sure to fix the problem before getting out of hand and putting you in the red. And if you need help with that you can reach out to us and book a consultation call with Annette Ferguson or you can subscribe on our YouTube Channel.
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