What causes cash flow problems in a small business?
03/08/2012 - Most businesses will suffer a cash flow crisis at some stage in their life.
What causes cash flow problems in a small business
Most businesses will suffer a cash flow crisis at some stage in their life. Adequate working capital is vital to the long-term viability of the business. The business might be profitable but without cash the business will struggle to meet its day-to-day financial commitments. There are many reasons why a business could be suffering a cash flow shortage, some of these reasons may be temporary; some long term.
A sudden downturn in sales
This may be caused by a decline in economic conditions, a more aggressive competitor or under cutting price. A business will rely on one or maybe two key customers to provide the bulk of their revenue. The loss of a key customer may leave a gaping hole in revenues.
Expenses exceed revenues
In its infancy a business will often run at a cash loss. After 2-3 years a business should be trading cash flow positive. If not, a careful examination of expenditures is in order to ensure that money is not being spent needlessly or on the wrong things. It is also advisable to examine marketing and advertising methods to determine their effectiveness.
Quite often a business prices its products and services too low. The common thinking is that the lower the price, the more demand there will be for their product or service. However, lower prices often result in lower profit margins that will lead to cash flow deficits and ultimately failure. If sales are good but you still are not making enough to meet your financial obligations, try increasing your prices.
Too many expenses
Stop to consider, could your business run effectively with three instead of five employees? Are you paying yourself too high a salary? Do your marketing and advertising campaigns cost more than they are producing? Look at all ways to minimise your expenses.
Poor collection methods
Slow-paying customers can cripple a business. If you are going to extend credit to customers, request at least three references and contact them. If you have slow-paying or no-pay customers, adopt a stringent process and begin collection procedures as soon as they are late. Remember you are not their financiers.
Offering a discount to new customers to encourage prompt payment is a good idea, however provided the discount is not too high. Discounts can cut into your profits, leaving you with a reduced cash flow.
Paying bills early
It is important to pay all bills on time. This preserves lines of credit, maintains your reputation and gives you stronger bargaining power with suppliers. You should still pay bills by their due date, but pay them as close to that date as possible. The longer you can keep that money in your account, the more positive your cash flow will be.
So what can you do about solving cash flow problems? Of course you can try to secure a bank overdraft. You could try to find an equity partner or you could consider another alternative — debtor finance.
Debtor finance utilises what is for many 'small medium enterprises' is their primary asset, i.e. the outstanding value of any trade debts offered on credit terms.
When a company increases its business levels and therefore the value of any outstanding invoiced debts, then a flexible cash flow solution such as invoice factoring or invoice discounting automatically expands with those debts thereby filling any potential funding gap for supplies, raw materials etc.
With a debtor finance facility you get paid up to 80 per cent of your outstanding invoices within 48 hours. Fees are charged on a sliding scale. The quicker you collect the less you pay.
It's flexible, you choose what invoices you include in the facility and there are no long term contracts or minimum volumes.
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