Whether you’re an established company or a small business just finding your feet, cash flow can be difficult to manage — but it’s a critical business factor to master. Every year around 20% of small businesses in the U.S. fail, and more than 80% of these fail due to cash flow problems.
This worry no doubt keeps many business owners awake at night, and most will do all they can to keep a close eye on cash flow. However, when cash flow issues occur, it can be hard to pinpoint their cause, especially for growing businesses. This is why consistently monitoring cash flow, and having visibility over money coming in and out of the business, is key to understanding business performance.
Although this can seem overwhelming, understanding the root cause of cash flow issues is crucial to mastering the art of cash flow management. Planning to manage or overcome these obstacles before they occur then helps secure business growth in the long run.
Why is Cash Flow Important?
Effectively managing cash flow is vital to business performance.
For small businesses in particular, growth (and even survival) means having enough money in the bank to pay for operating expenses, including paying suppliers, employees, and for utilities. Going back further, starting a business means buying inventory, launching marketing, rental payments, and other setup costs — all before the company has received so much as a nickel.
Without enough cash liquidity — i.e., the ability an organization has to access cash when it needs to — the business will face serious obstacles to its growth. If the organization then fails to address these obstacles in a timely manner, they can quickly turn into a major cause of financial stress, and even shut-down.
How Do Cash Flow Problems Usually Start?
Most, if not all, business owners will be aware of cash flow, or will at least grasp the importance of balancing money in versus money out when it comes to managing their business. Yet it’s common for small businesses to be caught off-guard by challenges that seemingly come out of nowhere.
That’s because there are multiple factors that lead to cash flow issues. Here are some of the most common:
Delayed payments are notorious for causing businesses headaches. There has unfortunately been a general trend towards late payments over the last few years, which hurt small businesses even more during tough economic times. A survey from Intuit QuickBooks found that as many as 73% of businesses are affected by late invoice payments — and around 40% of SMBs said that if this continued, they could be forced to close in the next year.
The effects of outstanding receivables on cash flow can be crippling. They impact small businesses’ ability to stick to financial plans, pay bills on time, and start or maintain their growth.
During periods of business growth cash flow management can be hard to plan. As demand starts to rise this creates the need for more inventory purchases, new employees, or outsourcing some operations. It may be that a business needs to obtain further financing to cover these new costs.
Growth does not necessarily lead to cash flow problems, but without a proper plan issues may arise. For many emerging companies, more demand can lead to more problems — and not always more revenue. As purchase orders start to climb, businesses need enough cash on hand to pay suppliers more frequently, and on time, which can sometimes be before customers have paid them.
Another potential side-effect of rapid business growth is the added difficulty owners have keeping track of cash coming in and out of the business. Proper forecasting requires accurate historical data and sales records, and must account for seasonality, market trends, and outliers.
Unfortunately small businesses often find they have limited access to this information. Historical data in particular is often not available for emerging businesses, and if it does exist can be too limited to provide a full, rounded picture of how their market will behave.
This in turn creates cash flow problems when uninformed forecasting leads to projected inflows and outflows not matching reality.
Another cause of cash flow difficulties that businesses overlook is poor inventory management. On paper it may make sense to over-order stock. In anticipation of demand rising, owners will want to be fully prepared to deliver on increasing purchase orders.
Yet if that demand doesn’t materialize, businesses end up with stock surplus to requirement. Cash reserves are therefore used for unsellable stock, impacting liquidity. Equally, if stock levels don’t match demand, more cash needs to be spent faster than expected, which in turn affects forecasts, and the business may need access to cash outside of its existing working capital.
How to Solve Cash Flow Problems
When cash flow problems emerge, businesses often feel the need to act fast. In the absence of existing spare revenue a common solution is to borrow money to cover operational costs. But this is not always straightforward. Traditional bank loans take time and are notoriously difficult to access for new businesses with little credit history.
An alternative is to pursue financing solutions more suited to small businesses with short-term cash needs. Invoice factoring, working capital loans, and purchase order (PO) financing can all help keep things moving when cash is needed quickly.
Cash Flow Forecasting
Making cash flow forecasts more accurate is vital for proper financial management. Businesses should consider setting up a process looking at income and cash flow statements on a regular basis, while connecting cash flow forecasts to working capital listed on the balance sheet.
This process can be refined by regularly reviewing the differences between forecasts and actual outcomes. Weekly cash flow reporting can show how reliable forecasting data is.
A tried-and-tested method of reducing cash flow problems is to cut down on the amount of cash tied up with outstanding receivables. Businesses large and small spend a lot of time chasing late payments from customers and clients, and persistence is often key to securing this.
There are ways to get ahead of this too:
- Send out invoices quickly and accurately
- Give customers multiple payment options
- Provide incentives for early payments — e.g., deals and discounts
- Track the status of all invoices and due dates
If these options are exhausted, another way to deal with late receivables so they don’t interfere with cash flow is to use invoice ‘factoring’. This option lets the business sell any unpaid invoices to a third-party which can help secure working capital to continue operations.
From procurement to storage and management, inventory is costly. Efficient inventory management can give owners greater visibility over how much cash is being used for stock and helps them order enough to hold at a level that meets changing levels of demand.
Inventory management software also lets businesses get an accurate understanding of cash flow, and what is under management at any given time. It can produce reports on turnover, for example, revealing which items are selling faster than others. Proper management also provides a clearer picture of how much cash is linked to inventory, what the total value of inventory is at any given time, and also makes it easier to anticipate demand.
Maintain Business Growth With Setscale
Business growth can often be touch and go, so avoiding cash flow problems that make you lose momentum is key. It’s especially important for many businesses to keep hold of their assets and maintain liquidity. Find out more about Setscale’s flexible PO financing solution, or get started by filling in a request form today. We look forward to helping you scale.