This article is part of our “Cash Flow 101” series. The ultimate guide to help you understand and manage your business’s cash flow, and prevent future cash flow problems. Check out the end of this article for more resources.
Though they’re by no means uncommon, cash flow problems can cripple businesses of all sizes, and smaller ones are perhaps more vulnerable. Without access to cash, even companies that are bringing in plenty of business can be at risk. The good news is that cash flow problems aren’t entirely out of your control—and they’re not unpredictable, either.
Proper cash flow forecasting and regular cash flow statement analysis or review, coupled with an understanding of symptoms that might indicate cash flow problems can help you protect your business and avoid a scramble to pay bills or make payroll.
If your business is suffering from any of these five symptoms, the key is to get ahead of potential cash flow problems so you can address them before you’re facing a cash emergency. It’s a lot easier to get a loan six months before your cash reserve bottoms out, than at the last minute.
1. Your accounts receivables are high
Many businesses invoice their clients and receive payment after the service or product is delivered, so it’s normal to have some unpaid invoices at any given point. The trouble is that until your customer pays, you don’t have their cash available to you to meet your expenses. You just have the promise of their payment.
If you find that month after month, your receivables are higher but you’re not bringing in more cash, it’s time to take a serious look at your payments terms and invoicing system.
The longer an invoice sits unpaid, the less likely it is that it will ever be paid at all.
To see whether your business is doing well with collecting its accounts receivables, consider keeping track of your receivables turnover ratio (net credit sales over average accounts receivables balance). A low ratio might indicate it’s time to reassess your payment terms and policies.
Check out this article on how to make sure your business is getting paid on time for more tips and insights.
2. You have high inventory and lower volume orders
Businesses that sell their products to other businesses may like to have a lot of inventory on hand to ensure they’re able to accommodate orders of all sizes. But if a majority of your cash is tied up in that inventory, and your customers aren’t racing to buy, you might start to see problems.
Until your inventory items are sold, you don’t have liquid cash available to pay your bills. Plus, you’re probably paying to store it, and you start running the risk of your inventory being damaged or stolen, or simply becoming obsolete or less in demand before you can move it.
To ensure your company has the products it needs to grow on hand while also being able to access cash when needed, it might be worth taking a hard look at your inventory management processes. Check out this article on reducing inventory costs for some ideas on where to start.
3. You’re overextending your business
Though you might be very eager to scale or grow your business quickly, it’s important you make sure to do so at a reasonable rate. If you overextend your company, chances are a lot of your cash will be tied up in capital and operating expenses, leaving your business less flexible in the short term.
To avoid having to deal with cash flow problems related to overextension, be sure to thoroughly plan your growth well in advance. Your sales forecast is essentially your growth plan for your business. Your sales goals should guide your expense budget. Strategically, when you make spending decisions, they should align with your sales goals.
You’ve probably heard the old adage that you have to spend money to make money.
The key here is to make sure you’re monitoring your financials so that you can make smart spending decisions with confidence. Don’t just spend and hope for the best—reviewing your key financial statements regularly—cash flow statement, income statement, and balance sheet—will help you get a fuller picture of where your business is and where it’s headed.
Make sure your analysis includes comparing your actuals against your forecasts (more on how to do this type of review in this article on monthly financial statement analysis). Don’t be intimidated—you can do this!
4. Your sales are declining
Maybe the economy is in shambles. Maybe you’ve got a lot of new competition. Whatever the case may be, if sales have been steadily declining over the last few quarters, there’s a good chance your profit margins are getting sliced as thin as possible—if they still exist at all.
Since your overhead costs likely won’t change, declining sales may indicate that cash flow problems are imminent. To combat declining sales, you might want to adjust your strategy, or at least your expense budget.
From there, look a little deeper:
- Where are your losses coming from? Is there a particular demographic where you’re selling less than you used to?
- Is there a technical or process-related problem? Is your sales page on your website broken? Are in-person customers dissatisfied with customer service?
- Are there macro-level changes happening in your industry right now that are affecting common benchmarks overall?
- When was the last time you redefined your buyer personas or looked at updating your messaging?
- Does your business model still make sense?
- Is your business experiencing a seasonal fluctuation?
If sales are off for a month or two, you might not have a huge problem to solve. But it is a good time to make sure you have a plan in place if you start noticing a longer-term trend. Mitigate risks by being aware of them to begin with, and making a plan to remedy.
If you’re not sure where to start, do a SWOT analysis to get a better look at your business’s strengths, weaknesses, opportunities, and threats.
5. Your business just isn’t profitable
At the end of the day, if you’re spending more money than you’re taking in, it shouldn’t take a rocket scientist to tell you that you’ll probably have cash flow problems sooner or later.
If you find yourself in such a position, you might want to reexamine your business model to see how it can be changed to enhance profitability. For starters, you could get creative and figure out how you can lower your expenses; for example, you might find that moving your computing infrastructure to the cloud will save money and increase productivity. It might also be time to think about whether it makes sense to increase your prices.
Noticing one of these symptoms in your business isn’t necessarily an emergency. Take the opportunity to look deeply at your financial performance, and make sure you’re thinking far enough into the future that you can get a loan or line of credit, if you’re coming up on a tougher period.
For more on cash flow:
- Cash Flow 101: The Basics
- How to Forecast Cash Flow
- Cash Flow 101: Building a Cash Flow Statement
- Free Downloadable Cash Flow Statement Example
- Cash Flow Analysis: How to Review Your Cash Flow Statement