What is one of the biggest issues facing startups, small businesses and even established businesses? Cash flow. Cash flow can make or break a business, and can be a pain point when cash flow management goes wrong.
Positive cash flow is essential for the smooth operation and growth of any business. It refers to the amount of money that flows into a company from sales, investments, or other sources, minus the amount that flows out through expenses and payments.
Maintaining a positive cash flow is crucial because it allows businesses to meet their financial obligations, such as paying employees and suppliers, investing in new ventures, and covering unexpected expenses.
However, many businesses struggle with cash flow issues, which can quickly escalate into a full-blown crisis if not addressed promptly.
There are several common signs that may indicate potential cash flow problems within a business. These include delayed payments from customers, difficulty in securing loans or lines of credit, an increase in accounts payable and outstanding bills, and low profit margins.
Other red flags may include decreased sales, high employee turnover, and an inability to pay bills on time. If left unaddressed, these signs can lead to a negative cash flow situation, which can significantly impact the stability and success of a business.
In this blog, you’ll see how your business can spot cash flow problems before they become crises and learn practical tips for preventing issues and improving cash flow management. By having a deeper understanding of cash flow and the potential warning signs of a problem, businesses can proactively address any issues and ensure their long-term financial stability.
Ready to improve your cash flow management? Let's dive in and explore the steps businesses can take to avoid a cash flow crisis.
How do cash flow problems usually start?
Cash flow problems can begin for a lot of different reasons. Small businesses can find that they initially spend money faster than they’re bringing it in, which can be where cash flow problems start. Uncontrolled growth can also cause issues as business owners struggle to keep up with new demand, being forced to pay expenses they may not yet be able to cover. A lack of understanding of cash inflows and cash outflows can also lead to a cash flow problem, and could signal wider financial management issues for the business.
Many common cash flow problems are temporary, while others can have a lasting impact on the business. Understanding the different causes of cash flow problems can help businesses take action, avoiding more serious issues further down the line.
Sign 1: Increasing accounts receivable days
How do cash flow problems usually start? Let’s start with accounts receivable days. Accounts receivable days refer to the average number of days it takes a business to collect payment from customers for goods or services provided. The longer this period is, the longer a business has to wait for incoming cash and the more likely it is to face cash flow problems.
As part of the range of KPIs (key performance indicators) used to track the financial health of a business, tracking accounts receivable days can help identify potential cash flow problems before they become crises. A significant increase in this metric may indicate that customers are taking longer to pay, which can be a sign of underlying issues such as poor credit control or late deliveries.
Besides cash flow issues, increasing accounts receivable days can also cause other problems for businesses, including:
- Strained relationships with suppliers.
- Increased administrative burden.
- Challenges with cash flow forecast.
- Increased risk of bad debt.
- Negative impact on credit rating.
To address this issue and improve cash flow, businesses can implement procedures to speed up collections, such as offering incentives for early payment of outstanding receivables, sending reminders and follow-ups for overdue invoices, or working with a third-party debt collection agency. Improved communication with customers could also help eliminate some cash flow challenges, and ensure more positive relationships going forward.
Methods for decreasing accounts receivable days
There are several strategies businesses can use to reduce their accounts receivable days and improve cash flow:
- Implementing strict credit policies: Establishing clear terms and conditions for payment, conducting credit checks on new customers, and setting credit limits can help minimise the risk of late or non-payment of your outstanding receivables.
- Offering multiple payment options: Providing various payment methods such as credit cards, ACH transfers, and online payments can make it easier for customers to pay on time.
- Implement automated invoicing and payment systems: Streamlining your invoice process through automated systems that generate and send invoices promptly.
- Segment your customers based on payment behaviour: Analyse your customer base and segment your customers based on their payment behaviour. Identify your highest-risk customers and work on targeted strategies to help them address their payment issues, including proactive follow-ups and stricter credit terms.
By implementing these strategies, businesses can significantly reduce their accounts receivable days and maintain positive cash flow.
Sign 2: Declining cash balances
Another warning sign of potential cash flow issues is the decline in available cash balances. A decrease in cash reserves can be caused by various factors, including:
- Slow-paying customers
- Unexpected expenses
- A decrease in sales
- Economic downturns
- Seasonal fluctuations
- Changes in market conditions
Businesses should regularly review and monitor their cash flow statements to ensure they have enough funds to cover their financial obligations. If they notice a steady decline in cash balances, it may be time to take action and investigate the underlying causes. It’s important to consider factors affecting individual clients and business owners, as well as those affecting the market as a whole. This can help establish the difference between common cash flow problems, and issues impacting the wider industry, so that businesses can adapt their strategies accordingly.
Strategies for increasing cash reserves
To maintain healthy cash balances, businesses can implement the following strategies:
- Reduce unnecessary expenses: Reviewing all business expenses and cutting back on non-essential costs can free up cash flow.
- Negotiate better payment terms with suppliers: Businesses can negotiate longer payment terms with suppliers, allowing them to hold onto cash for longer.
- Consider factoring or merchant cash advances: These financing options can provide businesses with immediate access to cash in exchange for future receivables or credit card sales.
- Explore alternative sources of revenue: Diversifying products or services and exploring new markets can help generate additional income and increase cash flow.
- Optimise inventory management: Adjusting inventory management practices to minimise excess inventory and help improve cash flow. Implementing just-in-time inventory systems, and conducting regular inventory audits can identify slow-moving or obsolete stock to make more informed decisions.
- Allocate profits to reserves: Businesses can set aside profits each month to help build cash reserves. Establishing a target reserve level based on risk appetite and financial goals can help prevent cash flow problems.
- Plan for contingencies: By anticipating and planning for potential financial setbacks or emergencies, businesses can set aside emergency funds specifically designed for contingencies. Even profitable businesses are known to establish contingency funds, protecting against cash flow shortfalls and other issues. This can give peace of mind for business owners and avoid the need for business loans and other funding sources.
By implementing these strategies, businesses can increase their cash reserves and have a buffer for any unexpected expenses or periods of slow sales.
Sign 3: Rising debt levels
A third sign of potential cash flow issues is a significant increase in debt levels. This can be in the form of outstanding loans, lines of credit, or high credit card balances. Late payment of invoices and bad debt can cause a company to fall into debt because they do not have enough cash reserves to cover their expenses. Rapid business growth can also lead to rising debt as businesses struggle to meet demand, taking on extra employees and other resources to get the job done.
High levels of debt can strain a business's financial resources and make it challenging to meet ongoing expenses. If left unchecked, it can lead to further borrowing and create a cycle of debt that can be challenging to break.
Business debt can spiral out of control for various reasons, such as poor financial management or unexpected events like a recession. To avoid a cash flow crisis, businesses should regularly review their debt levels and take proactive measures to manage and reduce it.
Solutions for managing business debt
There are several strategies businesses can use to manage and reduce their debt effectively:
- Create a realistic budget: A carefully planned budget can help businesses prioritise expenses and avoid overspending.
- Renegotiate payment terms with creditors: If facing financial difficulties, businesses can approach their creditors to negotiate more manageable payment terms or business credit interest rates
- Consolidate debt: Combining multiple debts into one loan with a lower interest rate can make it easier to manage and pay off.
- Monitor credit ratings: Regularly monitoring credit ratings can help track changes in creditworthiness and identify potential red flags. Where possible, inaccuracies or negative remarks should be rectified to avoid potentially damaging business credit issues.
- Seek professional advice: Businesses can seek advice from financial advisors or debt counsellors for strategies and solutions to reduce their debt.
Getting a handle on business debt can help businesses avoid a number of challenges, besides cash flow problems. Poor credit can hinder a business’ growth, and can make it difficult to access preferable rates for future loans, credit and insurance. By taking proactive steps to manage and reduce their debt, businesses can improve their cash flow and avoid potential crises.
Sign 4: Frequent overdrafts or declined payments
Overdrafts and declined payments are clear indicators of cash flow problems. They can lead to additional fees, damage relationships with suppliers, and negatively affect credit ratings, causing further problems within the cash flow cycle.
Both overdrafts and declined payments can cost businesses money and cause unnecessary stress. Therefore, it is essential for business owners to identify the root causes and take steps to prevent them from happening.
Businesses should regularly monitor their bank accounts to ensure they have enough funds to cover recurring expenses and obligations. If they find themselves frequently relying on overdrafts or experiencing declined payments, it may be time to take action.
Proactive financial management strategies can help businesses avoid these issues and maintain a healthy cash flow, preventing potential crises by addressing the root causes.
Actions to prevent overdrafts and declined payments
To avoid the negative consequences of overdrafts and declined payments, businesses can take the following actions:
- Create a cash flow forecast: By forecasting future cash inflows and cash outflows using accounting software and other applications, businesses can better anticipate periods of low cash flow and plan accordingly. It can also help businesses avoid late payments, which can also become a cash flow issue.
- Build a cash reserve: Setting aside a percentage of profits into a separate savings account can provide a buffer for unexpected expenses and help avoid overdrafts. Having more of the business money in reserve could help account for cash cycle changes, especially when it comes to seasonal fluctuations.
- Communicate with suppliers: If facing financial difficulties, businesses should communicate with their suppliers to discuss payment options or negotiate payment terms.
- Spending reviews: Regularly reviewing expenses and cutting back on non-essential costs can help free up cash flow and prevent overdrafts.
By proactively managing their cash flow and taking preventive measures, businesses can reduce the chances of overdrafts and declined payments. Prioritising debt repayments over other expenditure can help reduce the burden of debt, and prevent more serious cash flow problems in the long term.
Sign 5: Decreased profit margins without decreased sales
Lastly, a decrease in profit margins without a corresponding decrease in sales can also be a sign of a cash flow problem. This could be due to increasing expenses or poor financial management.
There are other factors behind decreased profit margins that can be outside the control of business owners. This can include pricing pressures, threats from competitors and changes in consumer behaviour. Understanding these factors could help you make adjustments to business operations, leading to increased sales and better cash flow management.
Businesses should regularly review their income statements to track changes in profitability over time. If they notice a consistent decrease in profit margins, it is essential to investigate the underlying causes and take corrective action. Professional accounting software could be a simple way to help monitor income statements, especially for small businesses that may lack dedicated finance employees.
Some of the most common reasons for declining profit margins include rising costs, pricing strategies, and inefficient operations. By identifying the root cause of the issue, businesses can implement practical solutions to improve their profitability and cash flow.
Solutions for improving profit margins
To increase profitability and address common cash flow problems, a business owner can consider implementing the following solutions:
- Review pricing strategies: Businesses can review their pricing strategy and adjust prices accordingly to maintain healthy profit margins.
- Reduce operational expenses: Identifying areas where costs can be cut, such as reducing overhead or streamlining operations, can help improve profit margins.
- Increase efficiency: By improving processes and finding ways to increase productivity, businesses can reduce costs and improve profitability
- Offer promotions or discounts: Temporarily offering promotions or discounts can help increase sales and improve cash flow, as long as it does not negatively impact profit margins.
- Monitor the competition: Understanding market trends can help you make better decisions regarding your prices and products, helping you boost your sales.
- Conduct some market research: Market research can help business owners understand trends within their target market, understanding the products and services they want so that businesses can ensure they stay relevant.
A proactive approach to improving profit margins can benefit businesses in several ways. Not only will it help businesses understand the market and their customers better, but it can help cut costs for more positive cash flow, while improving business operations overall.
By consistently monitoring and analysing their profit margins, businesses can make informed decisions to improve their financial health and avoid potential cash flow problems.
Nipping financial issues in the bud
Cash flow problems can impact businesses of all sizes, at all stages of their lifetime. It doesn’t necessarily mean that the business is being run poorly. Circumstances can be outside of the business’ control, such as economic events and changes in consumer habits. Whatever the reasons behind these cash flow challenges, it’s important to examine the reasons and take some action.
Monitoring these five signs can help businesses spot cash flow problems before they become a full-blown crisis. By taking proactive steps to address these warning signs and maintaining up-to-date cash flow statements, businesses can improve their financial health and avoid potential cash flow problems down the line.
With proper budgeting, debt management, and a focus on profitability, businesses can ensure a stable and sustainable cash flow that supports their growth and success.
Seeking professional financial advice, conducting regular reviews, and communicating with suppliers can also provide valuable insights and solutions to prevent or mitigate potential crises.
Staying vigilant and proactive in managing cash flow is crucial for businesses of all sizes. For more tips and strategies on managing business finances, check out the Chaser blog.
To learn more about how Chaser can help your business stay on top of cash flow, schedule a demo with an expert at Chaser today or start your 14-day free trial.
