All businesses run on cash. Managing money is an essential skill that all business owners should hone as the business progresses in its lifecycle.
Small business owners are often caught in a bundle of activities aimed towards business growth, with very little time or money to assign resources towards monitoring their cash flow. At this stage, there are many chances to derail your business due to mismanagement of cash. According to a report from CBInsights, 29% of businesses fail because they run out of cash.
Some common mistakes that can lead to cash flow issues include forced growth, miscalculation of profits, insufficient planning for a lean period or crisis, problems collecting payments and more. The first thing that illustrates a problem with cash flow is a dip in sales and a stagnant inventory, both of which directly affect your revenue. Poor money management and forecasting can lead to multiple cash flow gaps in your business, ultimately preventing you from paying your bills on time.
For your business to succeed, you must check for short term and long term solutions to avoid running into financial problems. Good cash flow management will ensure that you have enough cash to pay your employees on time, purchase inventory to fulfill your orders, have ample stashed in bank account as reserves, all while carving out an efficient way to collect payments before the due date. This will eventually prevent you from overspending and help you with your businesses’ growth plan.
In this article, you will read about common cash flow problems businesses face and what you can do to save yours from a pool of debt.
Common cash flow mistakes to avoid
1. Not monitoring financial statements
Financial reporting is the method of monitoring financial statements at defined time intervals. A cash flow statement is a financial statement that gives you a detailed insight of your company’s expenses. Investors and other stakeholders rely on this document to judge the value of your business. When you do not monitor your financial statements regularly, you create chances for misinterpreting your businesses’ progress, which may lead to bad decisions.
To avoid roadblocks due to cash flow, you must prepare a cash flow budget to predict future earnings. Good predictions are only possible when you have clear financials that are reconciled frequently.
2.Confusing cash flow with profit
Business owners are always on the lookout for that one key metric to understand the financial health of their business. In such situations, cash flow and profit are often pitted against one another.
Cash flow is the net income of cash moving in to or out of a business at any given time. Profit is the money that remains when you subtract the operating expenses from revenue.
It is possible for your business to be profitable and still have negative cash flow keeping you from paying regular expenses and creating hurdles in your growth plans. Your business can also have a positive cash flow and yet find it hard to make a profit (usually the case in start-ups and scaling businesses).
Cash flow and profit are not the same, and it is important that you understand the difference between the two before you make any important business decisions.
For example, assume that you purchase wooden chairs for Rs 6000 at a 40% margin and sell it for Rs 10000. You can assume that you are making 40% on every sale, after considering minor expenses. However, at the end of a quarter as you prepare your balance sheet, you could be surprised at the losses your business made. In your calculations you did not consider a variety of costs like transaction fees, shipping costs, and costs of storing and returns (which might have been different for each sale).
You could have easily assumed that you are making a profit every transaction, but after including overhead costs you can see the business actually took a loss. When your business cannot keep up with the losses, it becomes difficult to fulfil the cash commitments, leading to a cash crunch.
Forecasting the consequences of such expenses is a necessary step and can be helpful in determining if there’s enough money in the bank account to meet all your expenses. For a healthy cash flow, you must first subtract your current expenses and future costs, like tax, from your revenue. Your business will only be profitable if there’s any money left after this.
3.Unprepared for the lean period
Rainy days are inevitable in a business. You may not get payments on time, have insufficient cash to pay your dues, have to suddenly invest in repairing expensive equipment or lose customers during a crisis. Such excess expenses combined with insufficient financial reserves can drive your business bankrupt.
Planning the cash flow for your business is always worth the time. As a short-term plan, you can consider stashing away some money as a cash reserve. Financial experts suggest that you can ideally set aside three to six months of your company’s regular expenses as cash reserves. Of course, the best way is to find out your business needs and analyse your financial statements before fixing an amount.
You must also have a long-term cash flow outlook. This will help you forecast the cash required for business operations over a period of two to five years. The best place to start would be to monitor your current income and expenses.
Here are a few things you can do to save up:
- Set a monthly goal and set aside that amount every month.
- Maintain a separate account to prevent from spending it elsewhere.
- Always try and cut down on non-essential expenses.
- If you receive a lump sum as profit or receivable, try to allocate a decent part of it to this account.
Your main goal should be to accumulate enough cash as a safety net to meet your needs during lean period, irrespective of how well your business is performing.
4. Not focusing on late payments
Late payments disrupt the flow of cash in a business. You will need to spend a lot of time and effort to chase down customers who owe you. There are chances that your business might run out of funds, making it tough for you to pay your own bills on time and putting your own business at risk.
As a temporary solution, you can opt for loans to pay your suppliers and employees on time. However, it is still difficult to perform core business activities efficiently with insufficient cash in hand.
You must understand that late payments cannot be avoided but can be managed with the right plan of action. Here are a few suggestions:
- Clarify to your customers, in advance, about penalties you might charge in case of late payments.
- Since smaller businesses usually do not charge penalties on late payments from customers, you can set up payment reminders for receiving timely payments.
- If someone is unable to make payments for a prolonged period, try renegotiating the payment terms.
- Consider rewarding customers who make early payments. You can offer a discount on open invoices or provide them a free service.
5.Trying to expand too quickly
When your business is flourishing, you are faced with increased demands for your products and services. When it happens quickly, you may find it difficult for your business to adhere to the business financial plan that you had devised for the year.
Investing in a bigger office space, hiring more staff, and rolling out new products are but a few scenarios indicating forced growth. Although such initiatives may bring in more revenue from time to time, they can severely impact your daily operations if not planned correctly.
For example, let us assume that you are experimenting by investing in social media ads for your business. In the first month of investment, you receive a good return. So, you increase your ad spend three times expecting three times an increase in sales.
Even though you might generate more leads, what happens if your ad spend is not directly proportional to the sales? You might end up spending more than you earn, leading to inconsistencies in cash flow. You might need to take a short term loan to cover up your monthly expenses.
Forced growth can lead to problems like improper management of business, inability to manufacture inventory quickly enough to fulfil orders or difficulties in customer service.
Most business owners aim for sustained growth. Efficiently planning and estimating costs involved in expansion can help you manage your cash outflows better. However, you must also forecast and set aside money for paying your employees and suppliers on time and still have enough to pay for the office space while managing to convert the incoming cash into inventory orders. Your goal should be to fulfill all expenses that arise due to expansion in a single cash cycle.
6. Inconsistencies due to seasonal nature of business
Seasonal businesses are businesses that operate in one or two seasons in a year. Such businesses do not have a year-long operation.
For example, if you are selling winter wear, then the only time your sales might pick up is before and during the winter season. During the other seasons your sales may drop and there will be more outflow of cash.
As a business owner, you should find ways to make sufficient income to generate business during slow periods; this will help you maintain your cash flow. You can try partnering with businesses from other industries to create mutual benefits or to offer discount prices for your products. You can even implement creative solutions like hosting events to distribute your product samples, set up an online store or finding a niche market and create products for that audience.
7. Inefficient management of tax
Paying tax is an obligation and needs to be settled whenever it is due, whether you are a monthly, quarterly or annual payer. Missing out on the due date and making mistakes while filing returns can attract interest and penalties, and may even have the Income Tax authorities visiting your premises demanding an audit. Not only is it expensive, but it takes up valuable time from your day-to -day business activities. Hence, it is important that you keep account of your taxes.
You can meet with a tax consultant every year to calculate the amount of tax that you will be required to pay at the end of a financial year. You should come up with a tax plan after taking into account the cash flow needs of future business operations. A good tax plan accounts for all tax consequences and calculates your income, based on which you can plan activities for long-term progress. It also helps save your business from uncertain tax rates that can affect cash outflows.
Cash flow management plays a key role in keeping your business financially sound. To save your business from common cash flow problems, monitor the movement of cash closely and review your cash flow statements frequently. If you want to expand your business, draw out your receivables on time, incorporate tax payments while accounting your expenses, and monitor your profits. Avoid forced expansion of your business (if you cannot afford one) and prepare your business for the slow days. With a good cash flow management plan you can easily grow your business while fulfilling the obligations that come along the way.