A business can not survive longterm without healthy cash flow. Still, cash flow problems in business are common and keep a lot of entrepreneurs and business owners up at night. So how do you know if you have cash flow problems? And what causes them? Or what are short term solutions and how can you solve your cash flow problems structurally? Keep reading to find out!
Cash Flow Problems in Business – What Does It Mean?
Basically, your business has cash flow problems if the cash that is coming in is not sufficient to fund all your outgoing payments. That does not mean that you have cash flow problems just because you have negative cash flows for a while. It could be that you are experiencing lower demand due to a seasonal drop, or that you are investing in higher inventory levels for future sales. However, when your cash flow is always negative, meaning that your cash outflow is consistently higher than your cash inflow, you know that one day you will run out of cash if nothing changes. You are slowly using up your cash balances and need to investigate what the causes of your cash flow problems are.
Can A Profitable Business Fail Due To Cash Flow Problems
Yes, simply because profit is not cash. Your business can have a healthy profit, meaning you sell your products or services with a strong gross margin sufficient to cover all your other expenses. Unfortunately, that does not always mean that you have a healthy or positive cash flow.
When you invest in assets to support your future growth, the cash you pay is not recorded as an expense on your income statement. You might still be profitable when you look at your net income, but you are spending more cash than the cash that is coming in. This is not sustainable over a longer period and depends on your current cash balances.
When this net cash outflow continues too long, you might run out of cash. Once your cash runs out, you can no longer pay your employees, you can no longer buy inventory for future sales or you can no longer fund the development of your software products. When cash runs out, your business fails.
What Causes Cash Flow Problems in A Business
Cash Flow problems can have multiple root clauses. the following is not an exhaustive list, but sums up the most common reasons for cash flow problems in business:
- Low profit margins or operating at a loss
- Too high investments in future growth: R&D, productive capacity, international expansion, etc.
- Inventory levels are too high
- Outgoing invoices are not sent out on time
- Incomplete invoicing – not all products sold or services delivered are invoiced
- Allowing too much credit to customers – payment terms are too flexible
- Suppliers are paid before due dates
- Payment terms given by suppliers are too short
- Lack of a good accounting system
- Insufficient insight in cash flow
- Lack of consistent cash flow forecasting
How Do Small Businesses Deal With Cash Flow Problems
Many small businesses that encounter cash flow problems will resort to temporary solutions to increase their cash on hand in the short term. Common solutions are quick ways to increase cash levels, such as invoice financing or factoring, short term loans, etc. However, only a few businesses try to really determine the root causes of their cash flow problems. They do not look for solutions that lead to consistent healthy cash flows. For example, instead of getting a small business loan to cover temporary cash needs, a business owner might try to collect outstanding balances from his customers sooner. When you get a loan while your customers have overdue balances, you are basically financing their operations.
How To Solve Cash Flow Problems In A Business
Finding a quick solution by resorting to quick inflows of cash is the easiest solution. This will not solve your cash flow problems in the long term and might make your issues worse.
The best way is to avoid cash flow problems in your business altogether. You can do this by taking a number of initiatives that improve the way you manage your cash flow, such as:
- Streamline your invoicing process
- Implement an adequate accounting system
- Make sure you invoice all work performed and goods delivered
- Evaluate and renegotiate payment terms with customers and suppliers
- Pay your suppliers on time, not early!
- Review inventory levels and identify ways to manage inventory more efficiently
- Understand the main drivers of your business’ cash flow
- Prepare a meaningful cash flow forecast
- Analyze your actual cash flow versus the forecast – gain insight in what drives the differences and update your expectations for the future