No doubt the term “poor cash flow” is one that you’ve heard often - it’s what keeps most business owners up at night. At best it can eat in to your “future plans” savings and at worst it can sink your business. In fact, a survey by The Australian Bureau of Statistics reveals that 60% of the country’s small businesses go under within their first three years, and poor cash flow is one of the major reasons why.
So how do we define a poor cash flow situation? Essentially it means that you are consistently spending more money than you have coming in. Let’s say, for example, last month you received $4,500 in cash but you outlaid $5,000 - that leaves you with a negative cash flow of $500. Now, if that happens once or twice because of unforeseen circumstances you can often work around it but if it’s happening a lot then for the sake of your business you need to address it.
The good news is there are actually tons of ways to avoid negative cash flow. We’ve compiled the ten most common causes of poor cash flow and how you can fix them.
1. LOW PROFITS
Your profit is your major source of cash. It usually comes in from payments from your customers or through selling assets. If your business is unprofitable, you won’t have enough money on hand to cover all your outgoings. This might lead you to borrow more cash than you can repay or worse, close your business down.
There can be a couple of reasons why you aren't generating high profits:
- Your sales and marketing operations aren’t working well
- You've got low staff productivity
- You aren’t charging enough for your products
- Your ordering and delivery processes need improving
- You've got high and uncontrolled spending
Freshen up your marketing efforts. Maybe it’s time for you to revamp your website, your product catalogue, or your social media campaigns.
You could also consider participating in trade shows. Events like these are great platforms where you can showcase your products and capture new leads.
Also, try giving incentives to your staff. Doing this will encourage them to work harder and to focus on the targets that you have set. Your incentives could be in the form of certificates, food treats, or cash rewards and bonuses.
2. OVER INVESTMENT
It can be tempting to purchase things that we don't really need, especially if we have cash on hand. But spending money on non-business critical things will only drain your funds, meaning you won't have sufficient cash to pay for the items that really matter.
Before you purchase new equipment or invest in highend systems, decide if it’s really what your business needs right at that moment. It's often a good idea to keep a list of Must- Haves and Nice-to-Haves that you can review regularly so that when you're cash postive you know exactly what you need to spend money on to keep your business ticking along.
3. EXPANDING TOO FAST
Expanding your business too soon, without a concrete plan or sufficient money can put you in the red. For example, if you try to set up a new bakery location even before your current shop begins to earn a profit, or if you start paying rent in advance for your new warehouse space that you aren't quite ready for you'll quickly find that cash flow becomes a problem.
Expanding too fast can also mean growing your current operations too quickly. If things are going well it can be tempting to significantly increase your retail orders even if you don’t have enough resources in place to fulfill them, but remember that this can negatively impact your cashflow.
Maintain a disciplined spending plan and always have reserved cash in case of unexpected costs or emergencies. Also, it's a good idea to regularly perform a robust cash flow forecast.
A cash flow forecast is similar to a budget plan where you predict all your business’ income and expenses within a specific time period, (we'd suggest monthly or quarterly). It will help you manage all your outgoings and make it easier for you to determine whether you can afford to make those new investments or if you’re finally ready for expansion.
4. HIGH OVERHEAD EXPENSES
Overheads are your business’ ongoing expenses that aren’t directly related to the production and selling of your products. Some common examples are your rent, Internet, and other utility bills. While these costs are important in keeping your business doors’ open, they can hurt your cash flow, especially if they start getting out of hand. Once your overhead expenses grow too high, it can become difficult for you to pay them on time and you might eventually see yourself running out of money.
Review all your expenses. Bear in mind that you can never control your outgoings unless you have complete visibility over all your expenditures. Write down all your overhead costs, item by item, and from there, identify those that you really need and cut down on everything else.
If you think there’s nothing you can do without, try switching to cheaper options. You can consider moving to a smaller space with lower rent or shifting to a different service provider.
5. UNEXPECTED EXPENSES
Spending money on unexpected expenses or changes can put a strain on your cash flow. Usually, these changes are things that you didn’t foresee and did not include in your cash flow forecast. In short, you aren't able to allocate money to pay for them.
A few of the most common unexpected expenses are loss of staff, equipment breakdown, and an increase in market competition that requires your business to invest in new technology or equipment.
Cut back on non-essential outgoings. Regardless of how big or small that cut is, it will still make room in your budget to accommodate those unexpected expenses. If you have a monthly or yearly subscription that you no longer use, cancel it. If you have admin tasks that you do repetitively, consider automating it to reduce your expenses. The idea is to eliminate everything that isn’t necessary for your business so you can have more cash reserves in case of emergencies.
6. TOO HIGH WITHDRAWALS OR BORROWINGS
This happens when you withdraw too much cash out of your business or borrow money from loans but don't have sufficient profit to repay it. Sure, borrowing large amounts of money may prevent you from running out of funds in the short term, but keep in mind that it only delays a potential future financial crisis. In the end, it will still cause serious cash flow problems, especially if you aren’t able to work on your loan repayments. Remember that loans involve fluctuating interest rates and may sometimes require shorter repayment schedules.
Stick to your budget. If money is tight, don’t make decisions that will force you to borrow more money from loans or withdraw cash out of your business. Reserve as much cash as possible so you’ll have something to use when emergencies arise. The best practice is to set aside 6 months’ worth of operating costs.
7. HIGH (OR LOW) PRODUCT PRICING
Your product pricing also affects your cash flow position because it can lead to low profit... If your price is too high, no one will want to buy your products, but if you keep it too low, you won’t be able to generate the revenue you need to keep your business’ doors open. It's all about balance.
Keep the prices of your products competitive. Make sure they aren’t too low or too high to guarantee you’ll always have sufficient cash coming in. It’s even better if you can set different prices for different retail customers. Think about setting up “introductory offers” for new customers or offering lower pricing to bigger clients as they are ordering more products.
If you find yourself in a negative cash flow position and money is tight, there is one place you should look into straightaway: your inventory. Excessive inventory or overstocking can impact the movement of funds in and out of your business. When you stock too much of your raw ingredients or products, it can tie up significant amounts of money and occupy costly warehouse space.
What’s worse, products that stay on your shelves for too long can also be at risk of becoming outdated and unsellable making you less profitable.
Predict your orders. Estimate how many retail orders you'll receive in a week or month so you can stock just enough and ensure you won’t overproduce goods.
Good inventory management is also key. Keep track of your stock and review it regularly to guarantee it’s always within its use-by. An easy way to do this is invest in an inventory management system. It may seem like an extra cost but inventory management systems can help you identify the products that don’t sell and can provide you with inventory forecasting so you can avoid being out of stock or overstocked. In other words sometimes you need to spend money in order to save money.
9. POOR FINANCIAL PLANNING
If you fail to perform a good cash flow forecast and don't set your budget beforehand, you're more likely to suffer from cash shortages and could find yourself in serious financial difficulty. It doesn’t matter whether you come up with a great financial plan and an almost accurate forecast, if you’re following a negative cash flow business model you're going to find yourself in trouble.
What is a negative cash flow business model? If you give a 90-day payment term to your customers but you have to settle your rent, utility bills, and other overheads weeks before you get paid you'll find yourself with negative cashflow. No matter what you do, you are always going to be behind.
Set up your balance sheets, profit and loss statements, cash flow statements, and cash flow forecasts. This doesn't have to be scary. There are tons of templates and samples on the web that you can use as a reference.
But our best advice to you is this - if you want your plans and forecasts to be as accurate as possible, get yourself a professional accountant. An accountant can show you what you need to do and can even help you set up a system that can generate instant financial reports. Employ the experts so you can spend the time being an expert on your business.
10. LATE PAYMENTS
One of the major causes of poor cash flow is late payments. According to a 2016 SME snapshot from MYOB, late payments create an unhealthy cash flow cycle inside a business. 77% of SME owners reported they felt a negative impact from customers not settling their bills on time, while 35% said late payments have affected their personal finances and their ability to cover rent and other overheads.
Make payments easier for your customers. Among the many reasons why customers don’t pay promptly is they don’t see your payment methods as convenient or hassle-free. Try providing the payment methods they prefer. Whether that’s Cash on Delivery (C.O.D), bank transfer, or payments through all major credit cards and debit cards, offer it. You'll be surprised to see how fast they can settle their invoices.
It’s also good to let your customers pay you using the device they use most: smartphones. Start accepting mobile and digital payments. By doing this, they will have no reason to pay late.
Poor cash flow is a danger to the health of your business so always remember to budget smart, forecast well and pay close attention to all your accounts payable to ensure you always get on top of your cash flow.
Want more business advice like this? You may check out our blog.