Cash flow problems? What is that?
Cash flow is the number one problem in any business but it impacts smaller (newer) businesses more. Every business will encounter a cash flow problem at one time or another. Fortunately, most cash flow problems can be prevented with a bit of preparation and the right strategy.
Here is a list of the 5 most common cash flow problems, along with ways to solve them.
High overhead expenses
Overhead expenses also known as fixed costs. These are the costs of running a business that are not tied directly to selling a specific product or service. These are generally the same amount (or close to it) monthly. Examples of overhead include rent, telephone, utilities, etc. High overhead expenses can hurt your business’s cash flow.
High overhead expenses are particularly challenging because they are persistent. These expenses affect your cash flow every day and month until the problem is corrected.
The solution to this problem is simple, but it is not easy. Run through your expenses and cut back where you can. Be careful not to cut too much, as that approach could also hurt the company. You want your business to be lean but still fully functional. Do not simply dump the work of two employees onto one so you can cut the salary bill. Try and make the existing staff efficient and effective.
If you cannot cut back, consider cheaper options for your expenses. Many companies use the services of friends or family because that is how it always has been done. This may not be the most cost-effective for your business.
- Slow-paying invoices
This is a common cause for cash flow problems. As a small business, you have to offer 30-day to 60-day payment terms to clients. However, small companies can’t always afford to wait this long for payment. They need money sooner. Eventually, slow payments create a financial problem that can seriously affect your business even if it’s growing quickly.
There are two ways to solve this problem.
- One solution is to provide clients with an incentive to pay faster. Offering a 2% discount in exchange for a payment in 10 days can motivate clients to pay quickly. However, this incentive needs to be negotiated directly with each client.
- Use a process called invoice factoring to finance slow-paying invoices. This method improves cash flow immediately and enables you to offer payment terms with confidence. If you are considering this route – do your research because it cost you a significant amount in fees.
3. Excess inventory
This problem can affect companies that manufacture goods or re-sellers that keep a warehouse stocked with products. If too much product is made or purchased, it ends up sitting on shelves and tying up cash flow.
Fine-tune your inventory so that you stock items for the shortest possible time before being sold or used in the manufacturing process. The amount of product you keep in stock depends on your volume, sales forecasts, available cash, and supplier capabilities. Monitor inventory levels carefully. Having key products out of stock is a sure way to lose clients.
Companies that re-sell products can also use purchase order financing to finance large sales that exceed their cash flow capabilities. When used correctly, purchase order financing can improve your cash flow and allow you to finance the supplier expenses associated with large orders.
This point also relates to the theory in point 1 about being a lean business. You can trim the extra ‘fat’ by producing only what you need or managing your stock levels accurately.
- Too much bad debt
Bad debt occurs when you sell a product, or provide a service, to a client who does not pay. Bad debt presents obvious harm to your cash flow and your profitability.
The solution to this problem is to review the commercial credit of your clients before you extend payment terms. Provide terms only to clients who have good credit and a solid payment record. Others should prepay until they have built a track record with your company. This strategy may cost you some sales. However, it will only cost you clients who were deemed credit risks, to begin with. You would rather lose that sale than give the product or service away and not be paid!
- Insufficient gross margins
Small businesses sometimes sell their products and services for such low prices that they have low, or negative, gross margins. This scenario often happens in highly competitive environments with constant pricing pressure. It usually affects small business owners who do not have a clear understanding of their costs.
To solve this problem, audit all your products and services to determine the all-inclusive cost of delivering your products and services. This step is difficult but necessary. Once you have determined the all-inclusive cost, do the following:
- If you can, raise the prices of products/services that have weak margins
- If you can’t raise prices, consider dropping products/services that have weak margins
- Ensure that all proposals price your products according to their cost
One thing to keep in mind
Cash flow problems can be serious and threaten your ability to stay in business. If you don’t have direct financial experience, consider working with us at bc accounting services because we are financial experts and can help you determine which problems you may have – and how to solve them.
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