5 Cash Flow Problems Every Business Should Avoid (How to Solve Them)
Are you a small business owner struggling to make ends meet despite having steady sales?
You’re not the only one. Managing cash flow is a challenge for most businesses from time to time. Cash flow problems can make it tough to pay employees and keep suppliers happy, and even lead to bankruptcy in extreme cases.
In fact, according to a U.S. Bank study cited by the National Federation of Independent Businesses, 82% of business failures are due to poor cash flow management.
To help you avoid that fate, this article covers five common cash flow problems many entrepreneurs face and provides solutions to help get your finances back on track.
Cash Flow Problem #1: Not Maintaining a Cash Buffer
JPMorgan Chase Institute surveyed 600,000 small business owners about their cash reserves.
The results were startling: most small business owners have just 27 cash buffer days, defined as the number of days of cash outflows a business could pay out of its cash balance if its inflows were to stop.
Moreover, roughly one-quarter of businesses have less than 13 cash buffer days, meaning they could keep the doors open for less than two weeks if revenue suddenly dried up.
The Solution: Build Up a Business Emergency Fund
An emergency fund is a crucial safety net during uncertain times or when facing unexpected expenses.
It can provide a financial cushion when you face cash flow problems, allowing you to continue operations and meet your obligations without taking on more debt.
Don’t have an emergency fund? Here’s how to get started.
- Determine how big of an emergency fund you need. Bank of America recommends having an emergency fund of 10% of your annual revenue or at least three months of business expenses. However, you might need up to six months or more if your business is particularly prone to seasonal fluctuations.
- Set aside regular contributions. Rome wasn’t built in a day, and your business emergency fund doesn’t have to be fully funded overnight. Develop a habit of allocating a portion of each month’s profit to your emergency fund. Even small amounts can add up to healthy cash reserves.
- Separate funds. Keep the emergency fund separate from your general business account to avoid confusion and accidental spending. Consider opening a high-yield savings account. With interest rates higher than they’ve been in decades, a high-yield account allows you to earn a better rate on your savings and grow your money faster.
Cash Flow Problem #2: Revenue is Trapped in Past Due Accounts Receivable
Operating with lax credit and collection policies often leads to significant cash flow problems.
According to a study of payment practices by Atradius, a debt collection service, 93% of businesses experience late payments from customers and, on average, companies write off 1.5% of their receivables as bad debt.
This lack of proper cash flow management can be detrimental, especially for small businesses that need readily available funds to cover operational expenses.
The Solution: Create Better Credit and Collection Policies
Improving your credit and collection policies can help secure your revenue and prevent cash flow shortfalls. Here’s how to ensure uncollectible accounts receivable aren’t causing cash flow issues.
- Implement a credit policy. All customers don’t have to get the same credit terms. Establish a credit policy where customers must meet specific criteria before being offered terms. This could include credit checks or requiring a deposit for new customers or large orders.
- Prompt invoicing. The sooner you send an invoice, the quicker customers can pay you. Aim to send invoices immediately after you deliver a product or perform a service. Ensure your invoices clearly show all payment terms, including due dates, accepted payment methods, and any penalties for late payments.
- Follow up on overdue payments. Establish a systematic approach for following up on outstanding invoices, such as sending reminder emails, making phone calls, and, in severe cases, referring the account to a collection agency.
- Offer incentives. Consider incentivizing early payments with discounts. This can encourage customers to pay sooner, improving your cash flow. According to Oracle NetSuite, typical discounts fall in the 1% to 2% range. For example, a 2/10 early payment discount indicates a 2% discount if the customer pays their invoice within ten days.
Cash Flow Problem #3: Failing to Make Cash Flow Projections
Failure to make cash flow projections is like navigating unfamiliar territory without a map.
Without an accurate forecast of cash inflows and outflows, it’s easy to find yourself in a tight spot financially. For instance:
- A big loan payment comes due at the same time as you’re planning some big equipment purchases.
- You need to pay expenses, but you’re waiting on your largest customer to pay an invoice.
The Solution: Create and Regularly Update Cash Flow Projections
Cash flow forecasts provide a roadmap for your business finances, enabling you to plan for future expenses and investments and anticipate potential shortfalls.
By regularly forecasting your cash inflow and outflow, you can make informed decisions about allocating resources, managing risks, and planning.
Check out our article, How to Create Cash Flow Projections, for a step-by-step guide to predicting how much cash you’ll have available each month.
Once you start predicting times when poor cash flow might throw a wrench in your plans, you can take steps to bolster your cash balances, such as:
- Arranging a business line of credit,
- Putting extra effort into collecting slow payments
- Asking creditors to extend payment terms
- Looking into invoice financing, or
- Injecting some personal funds into the business
Avoiding cash flow problems before they arise can keep your business running smoothly, even in uncertain times.
Cash Flow Problem #4: Cash is Tied Up in Inventory
When customers want to buy from you, the last thing you want them to hear is that the item they want is out of stock. So, you keep extra inventory on hand to ensure you don’t run out.
But another source of common cash flow problems is having too much inventory on hand.
A recent survey from Inventory Planner found that 42% of small- to medium-sized retailers struggle with excess inventory. This can happen for various reasons, such as overestimating demand, ordering in bulk to get a discount, or offering too many product options.
While inventory is necessary for most businesses, having too much of it ties up your liquid cash and prevents you from investing in other areas of your business.
The Solution: Practice Effective Inventory Management
Effective inventory management strikes that balance between having enough stock to meet customer demand and avoiding an excess that causes cash flow problems.
Here are a few key strategies to enhance your inventory management:
- Leverage an inventory management system. Your accounting software might include inventory tracking features, but is it a true inventory management system? The right solution helps prevent excess inventory and improves cash flow by accurately forecasting demand using sales data, market trends, and customer feedback. This helps prevent overstocking and wasted cash.
- Regularly review inventory metrics. Keep track of your inventory turnover ratio, which measures the number of times you sell and replace inventory in a given period. A low ratio could indicate excess inventory that needs to be addressed.
- Negotiate favorable terms with suppliers. Ensuring you have competitive pricing and payment terms with your suppliers can help reduce inventory costs and free up cash for other business expenses.
Cash Flow Problem #5: High Overhead Expenses
Overhead expenses are costs essential to running your business but not directly linked to creating a product or producing a service. They include rent, utilities, insurance, and management and administrative staff salaries.
While these expenses are essential, if they become too high in proportion to your revenue, they can cause cash flow problems.
For example, a sudden increase in rent or utility bills can eat into your available cash and make it difficult for you to cover other expenses. Or if your sales are down for a month or two, you may struggle to make payroll.
The Solution: Monitor and Reduce Overhead Costs
To avoid cash flow problems due to high overhead, it’s crucial to review and assess your expenses regularly. Here are some steps you can take:
- Analyze all of your overhead costs. Look at your financial statements to see where your money is going. Are there any expenses you can cut back on or eliminate?
- Negotiate lower rates for services. Don’t be afraid to negotiate with suppliers and service providers to try and get better deals. This could include negotiating payment terms, discounts for paying early, or prices based on volume.
- Consider alternative business models or locations. If your rent and utilities are eating up a significant portion of your budget, it might be time to consider a different location or a new way of doing business that reduces overhead costs.
Strengthen Your Cash Flow Management with Finmark
Delayed payments, high overhead expenses, excessive inventory and lack of cash reserves can all be sources of cash flow problems if you don’t use a cash flow forecast to predict the cash flow cycle and get ahead of potential issues.
Finmark can help you track and analyze your cash flow so you can proactively work to have enough cash on hand to pay bills, cover salaries and wages, and fund business growth.
Don’t wait until you’re in the red to take action.
Cash flow problems happen, but they’re not inevitable, and they don’t have to lead to business failure. With the right tools and strategies, you can maintain a healthy cash flow and keep the proverbial lights on for years to come.
This content is presented “as is,” and is not intended to provide tax, legal or financial advice. Please consult your advisor with any questions.