Introduction to Cash Flow Problems
Cash flow problems have the potential to push businesses into depths of irrelevance.
Cash flow is one of the most significant determinants of the financial health of a business. A consistent cash flow helps businesses survive the VUCA world through risks and triumphs. While expense frauds and tricky budgeting issues can make CFOs twist with discomfort all night, cash flow problems are the stuff nightmares are made of.
What Is a Cash Flow Problem for Businesses?
Cash flow problems arise when the company’s liabilities exceed the liquid cash resources. In other words, when the cash inflows are not enough to cover the cash outflows, it means you have a cash flow problem. This puts your business in a tricky position as it struggles to meet its expenses and debt obligations.
Cash flow problems can cause irreparable damage to the financial health of a business. While these issues can strike mortal blows on small enterprises, they can also inflict painful financial wounds upon well-established large companies. According to Business Insider, 82% of small companies fail due to cash flow problems.
Importance of Cash Flow
A cash flow is the movement of money in and out of a company over a specific time period. It helps finance professionals determine the financial standing of a business and aids expense planning.
Balancing cash inflows and outflows can enhance expense transparency and help CFOs optimize their operational expenses. It helps them decide the amount needed in cash reserves to survive the troughs in revenue and peaks in unpredicted costs.
Cash flow also helps you identify the best-performing parts of your business and helps you identify and eradicate the bottlenecks in the spending process. It also enables you to recognize and utilize scaling opportunities and readies you for future challenges.
Instrumental in financial analysis and final expense audits, the cash flow statement also details the overhead and incidental payments by the business that are not listed under the profit and loss statement. Hence, it helps the finance officers understand precisely where and how the company spends its resources.
A cash flow statement also facilitates a critical financial process called cash flow forecasting. It helps businesses predict the future inflows and outflows of money and allows companies to become risk-resistant.
Difference Between Revenue and Cash Flow
Revenue is the amount of money the business generates through direct sales of the product or service. On the other hand, cash flow is the net movement of funds in and out of the company.
Revenue, profit, and cash flow are all used to analyze the financial performance of a business. However, while revenue is a better indicator of a company’s selling success, cash flow gives a more holistic picture of the business’s overall financial health.
Difference Between Profit and Cash Flow
Profit is the net amount of money you have left from your revenue after you have paid all the expenses. While profit is a crucial indicator of company performance and financial health, it only gives you a static figure and does not detail the movement of cash outflows. Cash flow becomes a more important metric to track on a regular basis as it gives a more comprehensive insight into company spending.
Leading Causes of Cash Flow Problems
Debt is rarely a happy word for individuals- this applies to businesses, too. Expensive debt payments and high interest rates can regularly drain the company’s profits and cause cash flow problems. CFOs should hence be wary of high-interest credit cards and significant business loans.
Revenue and sales troughs
Selling products and services at below-market standard rates may be an accepted penetrative pricing strategy, but it can lead to low profits, resulting in cash flow problems. Competitive discounts and deals can also drill a hole into the company’s pockets.
Insufficient cash reserves
Cash reserves help businesses stay afloat when sales drop, and revenue takes a hit. Companies with insufficient cash reserves can suffer from cash flow problems as they cannot remain functional after revenues drop.
Businesses in a high-growth phase are prone to cash flow mistakes. Finance teams can over-forecast the inflows, which may lead to an imbalance between expenses and revenues.
Late payments on receivables are one of the most common causes of cash flow issues. When receivables worth a considerable sum are outstanding, it can skew your cash flow forecast and make your business financially vulnerable.
Over-investing in inventory
Sometimes, businesses may buy a lot of inventory based on positive sales forecast results. If this inventory does not sell and the usability of the stock is time-sensitive, it can cause a severe cash flow problem in the business.
High overhead expenses
Overhead costs are administrative costs that do not fund the sales of a company but rather support various functions. For example, some overhead expenses include office rent, utilities, legal expenses, accounting, and travel.
Businesses spending disproportionate amounts on these expenses can result in a cash flow issue. To avoid this, CFOs should ensure that expense audits are conducted on a regular basis so that bottlenecks are promptly identified and eradicated.
Inconsistent bookkeeping and inaccurate forecasting
Having consistent and accurate bookkeeping practices is vital to cash flow management. Finance officials should regularly review and analyze their cash flow statements, payables aging, and other accounts. Even slight discrepancies in bookkeeping can lead to long-term issues.
How Do Cash Flow Issues Affect a Business
Cash flow problems can present businesses with many challenges. Let’s discuss some of them-
- Additional debt- Debt is a vicious spiral that businesses sink deeper into when they experience cash flow problems. A company with cash deficiency may incur debt to pay for immediate expenses and, in turn, increase the long-term issues of the business.
- Decreased credit ratings- When businesses fail to make timely interest payments or debt repayments, their credit ratings might take a hit. This can create problems when the firm tries to acquire loans in the future.
- Strained relationships with vendors- Cash flow problems lead to a lack of funds, which may cause a delay in vendor payments. This can sour the company’s goodwill, ruin its reputation and jeopardize long-standing relationships with essential vendors.
- Employee morale may take a hit- Cash flow problems may force you to delay your employees’ salaries. This can harm employee satisfaction and even reflect in the attrition rate.
- Insolvency- In the worst-case scenario, your business will not be able to survive cash flow problems, no matter the nature of your sacrifices and the level of damage control.
How Can You Solve Cash Flow Problems?
Cash flow problems are best solved through avoidance. Regular expense analyses, cash flow forecasts and prudent allocation of resources can help you avoid cash flow problems altogether. However, if your business is already experiencing cash flow problems, here are a few things you can do to control the situation.
1. Minimise expenses and eliminate clutter
Cutting expenses is challenging but crucial to saving your business from tumbling. Prioritise your costs and analyse the company’s expense reports to detect the most wasteful areas and slash out unnecessary luxuries.
A few ways of reducing expenses are-
- Letting employees work from home
- Decreasing incidental expenses
- Reducing operating expenses
- Cancelling inessential services and subscriptions
2. Plan ahead on receivables
Keep a close watch on your billing cycles and send invoices early. Reach out to your customers with outstanding due balances and ask them to clear the payments. Ask for partial payment upfront to ensure that your business does not fall behind on receivables.
3. Consider borrowing
You can take out a loan to stabilise your company’s cash flow. Ask your financial provider what options you can consider.
Be advised that while loans can give you short-term relief from debt, they come with their own set of challenges. Loans and interest rates can have long-term consequences that you may be able to recognise only in hindsight. If you choose to take a loan, analyse the loan plan and develop a long-term repayment strategy with your finance team.
4. Try to reduce payables
Reducing payable accounts is a great way to minimise expenses and induce positive cash flow. Talk to your vendors and see if you can get better deals with them that can help you save money.
Tackle Cash Flow Problems on an Elementary Level
Bouncing back from cash flow problems is a significant challenge for CFOs. While it may seem almost impossible for some businesses, certain resources make it possible for companies to recover from this nightmare.
However, if the reason for your cash flow problems is internal, external resources or temporary measures like reduction in expenses and additional debt may not be able to fix it. Identify the causes of your cash flow problems on the ground level. Once your business is out of survival mode, you focus on eradicating these base-level problems.