Cash flow can denote the health of a company and plays a major role in its potential success. You can consider cash flow to be made up of three main aspects: how much money is coming in, how much money is going out, and how much capital the business can access.
For a small business, a lack of good cash flow can leave the company in dire straits. Without consistent capital to manage everyday expenses, a company would be unable to maintain itself and would have to downsize or even shut down. If you’re an owner of a small business or planning to launch a venture soon, you need to know why companies face cash flow issues so you can avoid them.
Poorly planned finances
What's Inside
Many people start a business with a great idea, but also with a terrible business plan. Let’s say that you come up with a product that is sure to be a hit in the market, such as a modular, high-end laptop. You need running capital to operate a factory, hire workers, research and development, and market your product. If you do not plan your finances properly, you might end up being unable to deliver the product even after sinking a good amount of money into the venture. You need the means to create a financial forecast and budget and regularly update and maintain those documents.
In this situation, it would be a great idea to partner with someone who has an accounting master’s degree or similar qualification to oversee cash management. The right financial planning not only helps small and medium-sized businesses maintain a net positive cash flow, but it can also help you prepare for patches where your cash flow is negative. As your company begins to succeed, a financial planner can help make sure you expand in a sustainable way.
Ineffective expense strategies
All businesses have operational costs, but you can keep those costs as low as possible by employing a great management strategy. Some common examples of these overhead expenses are your rent, Internet, and other utility bills. If these expenses become too high or the payment scheme is mismanaged, you could struggle to pay them.
Let’s say that you’re investing in setting up a new office. You need to ensure your permits and licenses are in order, you’ve sent out any preliminary notices you need to, and that payments made to suppliers have been completed in a timely fashion. A mistake in any one of these steps could have you incurring hefty penalties.
Similarly, you need to follow up with any tardy payments that need to be made into your account to ensure the money keeps flowing into the business. Having too much money going out while not enough is coming in can wreak havoc on your company’s liquidity.
Over-investing
When it comes to over-investing, most businesses make a mistake in either of the following ways.
- Spending on non-critical things
Some start-ups will start investing in the wrong aspects of the business after seeing a bit of success. It can be tempting to upgrade your computer systems every year if you have the money to do so, for example. You can argue that the upgrade would make work more productive, but that is not enough. Unless the expenditure would increase productivity to the point where you get a quick return on your investment, you don’t need to put the money down.
Similarly, you must avoid the temptation to buy ‘quality of life’ items for the office, such as a fancy coffee machine or monthly work dinners. Divide your wish list into must-haves and nice-to-haves, and stay away from the latter until you can see a long-term, high net profit. A piece of wisdom for general consumers is, “you cannot afford something until you can buy it twice.” This approach applies when it comes to business expansion as well.
- Expanding too quickly
It is completely possible for you to put your money in the right places at the wrong time. If your company has been doing well for the past six months, you might think of opening in a new location, bringing on a few more employees, or simply increasing the number of orders you take.
While these are all steps that a growing business would take, they come with their own set of growing pains. For example, you might be tempted to move out of a coworking space and get your own office. But if you make this move too soon, you’re significantly increasing your running expenses without generating enough daily revenue to cover it. Expanding too quickly would not only negatively affect your bottom line, but it could also leave you helpless in case an emergency arises.
Too many sales happening on credit
Accepting credit cards or offering installment plans can increase the number of sales you make. But this marketing strategy is only sustainable for larger businesses. When you sell a product on credit, you allow the customer to take a month or two to make the payment. However, your suppliers might want to be paid within fourteen days. If it’s in installments, you will receive only a fraction of the payment each month. However, your company has already incurred the cost of manufacturing, marketing, and selling the product.
For small and medium businesses, the best approach is to take upfront or cash payments so that they can have a consistent stream of incoming revenue. An increase in credit sales can affect your business’s cash flow, while a decrease may improve your financial position. You might be worried about losing out on sales without offering some credit options. In that case, it would be best to consult your financial planner to strike an ideal balance.
Conclusion
There are various ways to generate capital, including profits, loans, equity, free cash, investments, and other forms. Maintaining your cash flow is all about ensuring that the capital your company gets is higher than its overhead costs. In simple terms, you need to be sure the money coming in is greater than the money going out. With the help of this guide, you should be able to avoid some of the most common cash flow mistakes made by novice or overexcited business owners.
