Most companies will encounter a cash flow problem at some stage in their business life. Whilst this can have serious consequences, most of these challenges can be prevented with a bit of preparation and the right strategy.
To help you get to the root of your challenges and keep your business thriving, here is a list of some common causes of cash flow problems, along with ways I think can help to solve them:
1. Poor financial planning
It’s said that failing to plan is planning to fail. For many small businesses, the lack of a disciplined approach to financial planning is an ongoing cause of cash flow shortages.
Failure to forecast, plan and budget effectively often means that cash flow shortages occur when they could have been avoided. Effective financial planning will ensure that you spot cash flow shortages before they occur and allow you to take the necessary steps to improve your financial position before it becomes an issue. It could even help you to identify if additional funding is required and help you to secure it.
2. Declining sales or profit margins
Declining sales can have a devastating effect on your cash flow. A reduction in sales might be driven by an increase in competition from local or international competitors, a general decline in sales across your industry, or softening economic conditions or global factors such as the recent Coronavirus outbreak.
If your overheads stay the same against declining sales, you’re likely to find yourself in a dangerous financial situation quickly. You should continually review your gross profit margin to ensure that your pricing is competitive but doesn’t have your business running at a loss.
3. Consistent late payments
When it comes to common causes of cash flow problems, late payment is currently one of the biggest issues most businesses face.
When a customer misses a payment deadline it can put significant strain on cash flow. Without money coming in on time you may not be able to meet your own commitments such as paying suppliers or employees.
As soon as you realise that a customer is going to exceed credit terms you should update your cash flow forecasts to highlight any impending cash flow gaps. This will allow you to take appropriate action to ensure you don’t end up struggling financially.
You could alternatively negotiate an extension with your suppliers, offer another customer an early-settlement discount or approach the bank to extend your funding.
4. Poor inventory management
Poor inventory management can be a costly mistake. A glut of excess stock means that valuable cash is tied up in product that’s sitting with you rather than your customers. Additionally, if you buy in bulk and don’t turn over your stock quickly, there’s a risk that it could become obsolete and unsellable.
A strategic approach to inventory management will allow you to avoid the costs associated with poor stock management. You should have a clear inventory management system in place, monitor inventory levels carefully, undertake a physical stocktake on a regular basis.
5. Undisciplined spending
It is common knowledge that spending too much will put a strain on your cash flow. Whether it’s because you don’t have the time or resources to shop around so you overspend or because you purchase things your business doesn’t need, you must discipline your spending or your cash flow will suffer severely.
The first step to overcoming this issue is to analyse your expenditure so that you have a clear picture of your incomings and outgoings. This will highlight where all your money is going and where you can make cutbacks. Look at each outgoing and ask yourself two things: do I need this to be successful, and do the ends justify the means?
6. Seasonal variation
The majority of businesses experience seasonal highs and lows throughout the year. But, without the right planning, these seasonal imbalances can cause businesses to feel the financial impact.
When a business experiences a busy period, some may find it hard to meet the increased demand. Whilst in the quieter periods, it can be difficult to meet day-to-day running costs.
To keep your cash flowing all year round it is first essential to get to know your seasonal cycle. Over time your financial records will highlight trends which can steer your business decisions.
7. Low Sales Levels
Whether it’s due to deteriorating economic conditions, an increase in competition or a slowdown in your industry, even a small drop in sales can cause significant cash flow problems.
To minimise the impact this has on your business you could encourage customers to upgrade to higher value products or services, add on complementary items to boost your average sale price, or encourage customer loyalty so they stay with you for longer.