Positive cash flow is the lifeblood of any business. Yet cash flow problems threaten businesses globally. And the causes of cash flow issues vary, from macroeconomic issues (natural disasters, recessions, or social distancing) to issues within your business.
61% of small business owners regularly struggle with cash flow issues, according to the 2019 QuickBooks State of Small Business Cash Flow survey. And as a result of those cash flow issues, 32% of small business owners were unable to pay vendors, loans, themselves, or employees.
Planning for cash flow problems can empower you to cushion—or even avoid—financial blows to your business.
What are cash flow problems?
Cash flow problems happen when a business does not have enough liquid cash to cover its liabilities. When cash outflows exceed cash inflows, businesses may struggle to pay debts and other expenses.
Net cash outflows don’t necessarily indicate that a business has a cash flow problem. It’s common for businesses to experience a net cash outflow when making large payments or experiencing seasonal business fluctuations. Cash flow only becomes a problem when outflows exceed inflows. At that point, the business uses up its cash reserve and can no longer meet its liabilities.
Cash flow issues can arise from low-profit margins, problems invoicing and collecting payments, and over-investing in inventory or capacity.
Effects of cash flow problems on small businesses
When cash is short, it can impact businesses in several ways. Cash flow shortages can result in
- Late payments to suppliers, leading to strained relationships.
- Late or missed debt repayments, resulting in decreased credit ratings.
- Additional debt to cover business expenses.
- Missed opportunities to grow the business through investments.
- Negative impacts on marketing strategies and competitive advantages.
- Covering business expenses with personal funds.
- Reduced employee morale and unpaid wages.
- Reduced customer satisfaction.
- Business closures due to insolvency.
Understanding how and why cash flow issues commonly occur can help you address them before they affect your business.
8 common causes of cash flow problems
1. Lacking cash reserves
86% of small business owners in a 2020 Federal Reserve Banks survey said they’d need to take action if faced with a two-month revenue loss. Among them, 17% said they’d have to close their businesses.
Should revenue drop, most businesses should have enough cash to cover up to six months of expenses to avoid a cash flow crunch. However, performing a cash flow forecast is the best way to understand the amount of cash you should reserve.
2. Expensive borrowing
Debt payments can cause cash flow problems when a business can’t afford its financing. Business loans and credit cards with high-interest rates may take much of a business’s revenues.
In some cases, payment solutions like supplier financing can help businesses improve cash flow and avoid additional debt. Refinancing loans to secure lower payments or debt consolidation may also help make borrowing more manageable.
3. Decreasing sales or profit margins
Selling products and services at prices that are too low can result in low-profit margins. Similar problems can arise when sales teams offer discounts that cut into profit margins.
Often, this problem impacts small businesses that don’t have a well-developed pricing strategy. Reviewing expenses and pricing can help small business owners determine if they should adjust prices or discontinue products or services with weak margins.
4. Outstanding receivables
Late payments on invoices are a common cause of cash flow problems for small businesses. Between 2018 and 2019, small businesses averaged an 81% increase in outstanding receivables, according to the 2020 QuickBooks Cash Flow Survey. In 2019, small business owners surveyed averaged $78,355 in outstanding receivables.
When your cash is tied up in outstanding receivables, it can leave your business in a poor cash position. Reviewing payment terms and collection policies may prevent invoices from contributing to cash flow problems.
5. Uncontrolled business growth
Cash flow mistakes are common during high-growth phases. Cash flow shortfalls can come from over-forecasting growth and when expenses exceed working capital. If you’re in a high-growth period, it’s critical to recognize the difference between profit and cash flow.
6. Too much inventory
Over-investing in inventory can leave businesses in a pinch if sales don’t cover investment costs. Business owners should use an inventory management system to balance their inventory. Monitoring inventory can help them avoid overstocking and running out of key products. Keeping inventory on hand for the shortest time possible can help keep inventory from contributing to cash flow shortages.
7. Seasonal changes in demand
Many businesses experience seasonal fluctuations in demand. If business owners don’t account for these changes, they can lead to less-than-ideal cash flow situations. Cash flow projections and accurate sales forecasting can help small business owners plan for seasonal changes.
8. Inaccurate forecasting or bookkeeping practices
It can be relatively straightforward to keep track of business cash flow and forecast sales. But as a business grows, the business owner may reach a point where cash management becomes more complex.
61% of small business owners don’t know how much they spend each month, according to the 2020 QuickBooks State of Payments report. 62% said they’re unsure of how much money lands in their bank accounts each month.
If you’re struggling with cash flow management, you have options. Consider upgrading your accounting system and cash flow tools or hiring a bookkeeper.
How to solve cash flow problems
Cash flow problems can threaten your business’s health, whether you’re self-employed or a small business owner with employees. Fortunately, you can use these five tactics to help tackle common cash flow problems.
1. Create a short-term business survival plan
Break down your business plan, processes, operations, income, and expenses in your plan. If applicable, use job costing to review your business’s profit and loss statements and margins. Identify the lion’s share of expenses and profits in products, services, clients, and labor. The goal is to stay open by scaling back and slowing down.
Making this information accessible can give you an accurate cash flow projection under normal circumstances. And in extraordinary situations, it can help you predict how scaling back will affect your business.
2. Reduce expenses
While reducing expenses isn’t easy, your survival plan will bring essential and non-essential expenses into the spotlight. Depending on your circumstances, a few creative changes may help get you back to positive cash flow.
- Discontinue non-essential services temporarily.
- Expand virtual services.
- Cancel or reduce premium services.
- Move to a lower-cost supplier temporarily.
- Reduce operating costs.
If you find yourself trying to make the hard choice to lay off workers, consider these alternatives first. And if you think you have to shut your doors temporarily, ask yourself these four essential questions. Just don’t forget that you have options.
3. Speed up accounts receivable
It sounds simple, but the effects of faster payments are profound. And there’s a lot you can do to get paid faster.
- Send invoices earlier.
- Review your billing cycle and payment terms.
- Break up payments into project-based weekly or bi-weekly installments.
- Request payments from past-due accounts.
- Ask for a deposit or partial payment upfront.
- Encourage or incentivize early payments.
- Accept multiple payment methods.
It’s also a good time to collect any unsettled debts. If you’re finding you have a lot of outstanding debts, you can sell your debt through invoice factoring. In this case, the factoring company may pay you a percentage of what you’re owed. You’ll have cash in hand, while the company settles your client’s debt.
4. Negotiate accounts payable
Reducing or negotiating expenses is another way to encourage positive cash flow. With more working capital, you can prioritize expenses and prevent cash flow problems from spiraling out of control.
Start with utility providers and vendors who have a history with you. Be honest and willing to talk about flexible terms and payment options. If your cash flow is strained severely, be strategic about the payments you make. The legal consequences of not making payroll, for example, far outweigh those of not paying your cable bill.
5. Consider your borrowing options
Borrowing money is another way to balance your cash flow. Ideally, you opened lines of business credit when your financials were more positive. But if that isn’t the case, ask your current financial service provider what they can offer before turning to other lenders.
Although short-term loans can seem like a tempting lifeline when you’re experiencing cash flow problems, there are caveats. First, you’ll need to have a documented business plan and cash flow forecast to show lenders. Second, interest rates and other terms and conditions can have lasting consequences. So read the fine print before borrowing. Finally, if there’s an internal flaw in your business, a fresh injection of cash won’t solve cash flow problems. It will only delay them.
Bouncing back from cash flow problems
This year, a Seattle restaurant offered a $135 fine-dining menu to a full room every night. Amid the coronavirus, they closed their dining room. To adapt, they delivered family-sized meals, supported community gardens, and offered wine boxes and cocktail kits. Thanks to their swift response, they kept the cash flowing. And their business, although different, stood a fighting chance. If you’re experiencing cash flow problems, your business might slow down. But that doesn’t mean it’s come to a halt.
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