Cash flow problems can affect small businesses in many ways, causing missed payments, late fees and disgruntled suppliers or staff. If left unchecked, cash flow problems compound and can threaten the viability of your business. This guide covers identifying and addressing cash flow problems and preventing cash flow from being an issue in the first place.
What are cash flow problems?
Cash flow problems happen when money leaving your business exceeds cash coming in. That gap means you lack the cash to cover your operating expenses and liabilities and run your business effectively.
What are the common causes of cash flow problems?
Here's a breakdown of the most common causes of cash flow problems in small businesses:
Expensive borrowing
Too much debt can mean too much cash is going towards interest and repayments, preventing you from paying other business expenses.
Outstanding receivables
Most businesses have to pay their suppliers, staff and overheads before they get paid by their customers. If you offer extended payment terms to customers or they consistently pay late, this can exacerbate the cash flow gap between your income and expenses.
Too much inventory
Excess inventory is essentially frozen cash — you can't access it until you sell the stock. Over-investing in stock also means you risk getting stuck with products you can't sell, increasing carrying costs.
Seasonal fluctuations
Seasonal businesses tend to have uneven or sporadic cash flow, meaning there are parts of the financial year where your income is much less than your outgoings.
Uncontrolled growth
As your business grows, so do your overheads. If your company is growing very rapidly, these overheads may be payable before you've the cash to cover them.
Not enough cash reserves
Many businesses lack cash reserves or 'rainy day' funds to fall back on. Any sudden increase in operating expenses or demand can put you on the cash flow back foot.
Decreasing sales
It can happen — quiet periods lead to a decline in sales. There can be many contributing factors – seasonal, economic or industry-related — but fewer sales mean less cash flowing into your business.
Effects of cash flow problems on businesses
The effects of cash flow problems on your business can be wide-ranging, from hamstrung growth to diminished customer satisfaction.
Slower growth
Without cash in hand, you won't have the capital to explore new growth opportunities, like expanding your product range, entering new markets, or hiring staff.
Less flexibility
A lack of cash flow makes a business less agile, particularly during an economic downturn or when demand drops. Sudden changes usually require a cash buffer to keep the company operating while you adjust.
Increasing debt
Businesses must find a balance between operating expenses and repaying debt. If cash flow is low, you might be unable to cover both, leading to even more debt and fees for late or missed payments.
Staff morale
Employees know when a business isn’t as busy or makes fewer sales. Sometimes, this lull can rally people, but it can also lead to unhappy staff, especially if there are delays in processing payroll.
Smaller sales and marketing budgets
Sales and marketing are essential to getting more customers. But you may be forced to cut budgets if cash flow is low. While you might save money in the short term, less marketing could lead to fewer customers — and even more cash flow problems.
Customer satisfaction
The knock-on effect of the above problems can be lower customer satisfaction. Less cash makes it challenging to service customers efficiently, which can lead to complaints or, worse, lost sales.
Insolvency
The worst-case scenario of poor cash flow is insolvency, meaning you can't repay your debts. In that case, all your business assets, and potentially any personal assets tied to the business through cash flow financing, will be sold to pay back your creditors.
How to improve cash flow problems
While there are many ways cash flow can become a problem, you can also do plenty of things to improve cash flow problems — and avoid them altogether.
Here are the top four ways you can manage business cash flow:
1. Encourage customers to pay you promptly
Receiving payment on time is one of the easiest ways to alleviate cash flow problems. Start by using automated invoicing software. While your customers might have 7 to 60 days to pay (depending on your payment terms), sending invoices quickly will speed up the process. Then, make it easy for customers to pay by offering different payment methods: mobile payments, online banking, direct debit or credit card payments, for example.
2. Reduce business expenses
If your outgoing expenses exceed your incoming sales, it’s time to review your overheads and make the necessary adjustments. Some costs are unavoidable, such as rent and utility bills. Still, you can reduce non-essential costs or renegotiate contracts to get better rates. Identify these expenses using cash flow management software that tracks all your income and expenses — to the last cent.
3. Consider a price increase
Are you charging enough for your products and services? Review whether your prices are profitable. Sometimes, they are less so over time as suppliers increase their prices and your operating costs go up.
4. Manage your inventory
Inventory management software to track stock levels is another way to improve cash flow. If you have a warehouse full of unsold or expired stock, it’s time to review your inventory management processes. The aim is to avoid having too much or too little stock.
How to prevent cash flow problems
Preventing cash flow problems starts with a cash flow forecast. While predicting the future is near impossible, forecasting will help you identify cash flow problems and prepare adequate contingencies.
A cash flow forecast predicts cash inflows and outflows to help plan future spending. The key components of a cash flow forecast are:
Opening balance (cash in the bank)
Expected money in (either from sales or loans)
Expected money out (business expenses)
Net cash flow (this will show if your cash reserves have grown or shrunk)
Closing balance (cash in the bank)
Once you’ve prepared a cash flow forecast, run ‘what if’ scenarios, like a decrease in sales, seasonal events or economic trends, to measure how prepared your cash flow will be.
Cash flow forecast versus cash flow statement
A cash flow forecast helps predict your future cash flow. A cash flow statement focuses on past cash flows and provides insight into your current cash flow position.
Cash flow problems FAQs
How do cash flow problems usually start?
Cash flow problems usually start with late payers. If you're a small business, this can put you on the back foot, particularly if you've limited resources and tight budgets. You rely on customers to pay you on time so you can cover your bills.
What's a healthy level of cash flow?
A healthy cash flow is a positive cash flow — enough money coming in to cover all outgoings.
Some signs of a healthy cash flow are:
Steady cash flow — you’ve found a way to generate reliable revenue consistently.
Operating cash flow is higher than your net income — the money you make after tax and loan repayments.
Healthy inventory turnover — you’re ordering and replenishing inventory just enough to meet demand without too much excess stock. Find out how to calculate your inventory days ratio.
Can a company be profitable and still have cash flow problems?
Yes, even a profitable business can have cash flow problems. If your sales are strong, but you're not being paid, or you're spending too much, you might not have the cash flow to keep operating efficiently.
What's a poor level of cash flow?
A poor or negative level of cash flow means you're consistently spending more money than you expect to have coming in.
Improve and prevent cash flow problems with MYOB
With MYOB's cash flow management software, you can see how much cash moves through your business in real-time. You can use this information to spot cash flow problems and run a cash flow forecast to prevent the same issues from happening again. Get started with MYOB today.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.