Every company runs into cash flow problems at one time or another. Learning how to identify them early on is important. It allows you to manage them effectively and solve them quickly.
- Teaches you how to identify the seven most common cash flow problems
- Provides practical solutions that you can use now
- Helps you determine if you are over your head and need outside help
High overhead costs
Overhead costs are expenses that are not directly related to the specific delivery of your product or service. Examples include rent, electricity, and some salaries.
These costs are important to the business but can easily get out of hand. This problem can affect companies that are growing quickly. They impact the bottom line but contribute little to your revenues.
You can fix this problem by going through your business looking for resources that are not essential. Then, cut back on those resources. Be careful and avoid cutting overhead to the point it affects your ability to run the company.
Too much money tied in inventory
Managing inventory is difficult, especially for small business. It requires a very delicate balance. Too little inventory can affect operations and delay orders. Too much inventory, on the other hand, just sits in a warehouse unused.
Having excess inventory is expensive. It ties up cash and often leads to cash flow problems.
You can solve this problem by managing your inventory more carefully. Make sure that you have enough inventory to service your clients, but not too much more. Unfortunately, managing inventory is difficult. It usually requires expensive systems that few small businesses can afford.
A short-term solution to fix this problem is to use inventory financing. It allows you to convert inventory into cash. While inventory financing is costly, it can provide funds to operate the business during tight times.
Large clients usually ask for payment terms as a condition of doing business. As such, you have to allow them 30 – 90 days to pay an invoice. Offering payment terms is a cost of doing business. However, slow paying invoices tie up your cash. This can lead to cash flow problems.
There are a few ways to solve this problem. One option is to offer clients an early payment discount. A 2% discount on the invoice in exchange for a payment in 10 days often works well. This simple technique can improve your cash flow quickly.
If your clients cannot pay early, you can use financing to improve your working capital. Small companies can use options like micro loans or invoice factoring to accomplish this.
Larger companies that can’t qualify for a business loan should consider asset based lending. These allow you to finance accounts receivable and other company assets. They provide you with immediate funds to pay company expenses.
Adding too many customers too quickly
This problem is related to the previous problem. Your company can run into cash flow problems if you add too many customers too quickly.
This can be hard for business owners to see at first. Entrepreneurs always think that growth is good.
Fixing the financial part of this problem is relatively simple as long as you can manage the operational demands of growth. Just as with the previous problem, use financing to cover the cash flow gap until your company is financially strong. You can use a business loan, a line of credit, factoring, or an asset-based loan to do this.
Customers who don’t pay their invoices generate bad debt. Bad debt erodes your profitability and affects your cash flow. It doesn’t get simpler than that.
Remember the golden rule of customer credit: a sale is only a loan until the customer pays. The easiest way to avoid bad debt is to charge all your customers up front. Unfortunately, this approach does not work well for corporate and government sales.
Commercial and government customers always demand net 30 to net 60-day terms.
You can reduce bad debt by checking the commercial credit of your clients. Credit reports are affordable.
They are available from companies such as Dun and Bradstreet, Ansonia, Experian Commercial, and Cortera.
Low profit margins
One common source of cash flow problems is low profit margins. Companies in competitive industries face this problem constantly. They must lower prices to remain competitive. The problem is that they often lower prices to the point where they generate small profits or, worse, a loss.
Many business owners don’t know the actual “all-in” cost of delivering their product or service. This lack of understanding can lead to costly pricing mistakes. These mistakes often go unnoticed at first, but they eventually lead to serious cash flow problems.
Problems due to low profit margins usually suggest a serious problem with the business. This matter requires immediate action by individuals with finance and business operations experience.
Given the seriousness of this problem, consider retaining an outside financial expert. Evaluate your business with your finance team and determine the actual “all-in” cost of your services.
Develop a strategy that supports a profitable business operation. Never price your products/services so low that you do not generate sufficient profit.
An extremely large order
Small businesses often regard a very large order from a choice client as a sign of success. Large orders turn into large deliveries, which bring substantial profits, right? Well, only if you have the resources to deliver the order while running the rest of your business. Otherwise, you have a problem.
If you don’t have the resources to deliver the order, you face a stark choice. You can take the order but risk running into cash flow problems. Alternatively, you can pass on the order and let a competitor win the client. Neither alternative is attractive.
A very large order can actually put you out of business if you are not careful. One option is to get term credit from your vendors. You can fulfill the order if you can convince your vendors to give you credit for as long as it takes you to deliver the order and get paid. This is difficult to negotiate, but it can be done if your production and payment cycles are short enough.
Should you get outside help?
Every company runs into financial problems from time to time. If your business is regularly having financial problems, consider hiring an expert.
Cash flow problems, especially complex ones, can come from many sources. They are difficult to identify and fix. They often require a professional.