Poor cash flow management can cause huge problems for even the most profitable businesses. Until you find and fix the cause of cash flow problems in your business and put systems in place for managing it, your company can be at risk of failure.
For the stark truth is without cash, your business will be unable to meet its payroll obligations, be more likely to default on payments to suppliers and creditors, and in the worse case, be forced to cease trading.
Without well-defined and well-managed strategies to avoid running into cash flow problems and a plan to improve cash flow if such problems should arise, many companies will flounder, yours included.
In our 2-part article, we will be covering:
- The main cause of cash flow problems in any business
- How a part-time CFO can help you to avoid or resolve your cash flow problems and prevent them from recurring
It doesn’t matter if your product or service is outstanding, your market share is bigger than your competitors’, your team is highly productive or if you have a steady stream of new clients, your company is at risk of going under if you don’t have a firm grip on your cash flow.
Even if your business is experiencing a high level of growth, you can risk issues: expansion can exacerbate the problems caused by poor cash flow management.
Cash really is the oxygen on which every business depends. Without a steady supply of it, your business cannot survive.
That applies even if your company is profitable. Business consultant Bill McGuiness says, “The sad fact is that the majority of failing firms are profitable as they enter bankruptcy.”¹
Without clearly defined and well-managed strategies to avoid running into cash flow problems and a plan to improve cash flow if such problems should arise, many companies will flounder, yours included.
Cash flow management is not a short-term fix to a problem but should be part of the fabric of the business.
It is like an internal insurance policy for your business. Getting to grips with your income and expenditure and understanding where you stand today as well as in the months and years ahead gives you and the rest of your senior team a great sense of clarity and peace of mind.
It also makes it easier for you and your team to plan and make decisions.
For that to happen, you need to analyze and then manage the flow of cash in and out of your company on a weekly, monthly, and annual basis. You also need to create a cash flow forecast for at least three months ahead so you and your senior team are aware of when cash shortfalls are likely to occur. This will allow you to cover your working capital requirements.
The main reasons for cash flow problems
Essentially, your cash flow problems are likely to be the result of one or more of the following:
According to a 2015 report by Taulia Inc. in the US, “for the majority of respondents, Days Sales Outstanding (DSO) averaged 30 to 40 days, with more than 25% of suppliers waiting more than 40 days to receive payment.
Small business suppliers are waiting longer and longer to be paid after delivering goods. This trend greatly impacts their operation as cash flow is one of the biggest concerns facing today’s small and mid-sized businesses. According to Forbes Magazine, a lack of readily available working capital is the main reason many small and mid-sized businesses fail to succeed.
To fill this cash flow gap, suppliers often have to borrow at costly rates between payments – and that only works if they can qualify for a loan.
From a broader perspective, paying later negatively affects the financial health of the supply chain.“²
Similarly in the UK, according to a report by Bacs Payment Schemes Ltd (Bacs),³ more than three-quarters of respondents (76%) are being forced to wait at least a month beyond their agreed contract terms before getting paid.
The knock-on effect of this is that business owners have to make tough decisions to make it through the month. Some 20% of directors in companies that experience late payments say they have taken a cut in salary in order to keep cash inside their businesses.
Over a quarter (26%) use their operating lines to make ends meet and one in ten are experiencing one or more of the following challenges every month:
Some 23% claim the late payment situation is forcing them to pay their own suppliers late.
Poor collection from customers
Many companies don’t issue invoices quickly enough. They’re even worse when it comes to chasing up invoices.
If this is the case in your company, it’s important to realize that every sale has already cost your business something in terms of labor, purchase of raw material, warehousing, advertising, etc. If you don’t collect what you’re owed, you’ll be worse off than if you never made the sale.
American entrepreneur Nolan Bushnell is fond of saying that a sale is a gift to the customer until the money is in the bank. 4
Your fixed costs are too high
If it is to survive, your business needs to bring in more cash than it spends. If it doesn’t, its long-term survival is unlikely.
Three of your biggest fixed costs (expenses) are likely to be payroll, capital expenditure (equipment, hardware, and plant) and office costs.
Your prices are too low
It’s quite common for businesses to set their pricing levels at the low end of the market in a bid to win customers.
If their expenses rise, their profit margins get smaller. Unfortunately, if they raise their prices, they risk alienating customers who have become accustomed to the low prices.
Your sales are too low
The way many business owners tackle the problem of low sales is to look for new clients. That inevitably incurs more costs since it involves spending more on advertising and marketing to attract those new clients.
There are other more cost-effective ways of boosting sales. They involve encouraging your existing or dormant customers to spend more and to do so more often.
You’re giving customers too generous payment terms
If your payment terms are overly generous (say, 60 or 90 days rather than 30), you could find that your business is constantly having to make up the cash shortfall.
Allowing customers to pay in arrears for goods or services received is similar to offering those companies short-term unsecured loans, says financial advisor John Toppin, MA FCA.5
“This form of financing is a fabulous deal for the customer as it is commonly unsecured, interest-free and the customer can pay its debt well beyond the agreed credit terms if it likes,” he says.
“What is more, unlike bank lending, the customer rarely has to pass any form of credit check to obtain these generous and virtually unlimited credit facilities.”
This happens when your business experiences rapid growth (which forces you to invest in more inventory, equipment, buildings, staff, etc.) but you don’t have the working capital to match that growth.
You have too many bad debts
Even a couple of bad debts may be enough to put your own business in jeopardy. That’s why it’s best not to rely too heavily on one or two big clients.
You’re holding too much old inventory
Accumulation of old inventory can tie up your cash reserves and prevent you from buying more up-to-date inventory. If this is the case, you should look for ways to sell off as much of that inventor as quickly as possible.
Joins us in part II of this article to find out How a part-time CFO can help you to resolve your cash flow problems.
1 ‘Cash Rules: Learn and Manage the 7 Cash flow Drivers for Your Company Success’, McGuiness, Bill, The Kiplinger Washington Editors, Inc., 2000
2 “Empowering Suppliers, Insight into What Suppliers Use, Want and Expect from early Payment Programs” Taulia White Paper Q1 2015
3 ‘Late payments are forcing businesses to make tough decisions’, Bacs, www.bacsservices.co.uk, Feb 16, 2015
4 ‘Finance for the Non-Finance Manager’, Siciliano, Gene, McGraw-Hill Companies, Inc., 2003
5 ‘Cash Flow: Advice For Business Owners And Finance Managers’ Toppin MA FCA, John, Nomizon Business Publishing, Kindle edition, Sep 30, 2014-09-30