Maintaining an adequate cash flow is one of the greatest challenges of entrepreneurship. Every business is different and industry norms vary widely but every business requires positive cash flow to operate on an ongoing basis. Following are some of the most common reasons that companies struggle with cash flow and some universal solutions and best practices.
Your Accounts Receivable Collections Are Slow
Collections are usually the most obvious place to look when you find your company accounts balances are wanting. While this is not always the primary cause, even when your A/R days look pretty good, there’s always room for improvement. Start by reviewing your standard payment terms to see if they are appropriate for your customers, industry and most importantly, your company’s cash flow needs. If you don’t have standard terms, you should. If your standard terms don’t include a cash discount for early payment, you should consider doing so. Many companies have policies to always pay in terms when cash discounts are offered, so even a small discount can make the difference between them paying late and paying early.
Review your largest customers and their payment history. One or two big accounts can make a big impact if they slow-pay. Identify where you may have issues and address them one by one. Often, customers will intentionally drag their feet in an effort to improve their own cash flow. Not discussing slow payment issues essentially tells the customer that you’re okay with it. Make sure to have those conversations and if you need to make special accommodations, don’t be afraid to do so if it benefits your business.
Don’t forget to review your internal operations as well. It’s quite common that the source of slow payments are created by poor operational practices on your end, not the customer’s. Make sure that customers are being billed promptly, frequently and accurately. If you find internal issues, fix them first.
You Have Unfavorable Accounts Payable Terms
This is the opposite of the A/R issue. In every business, there’s a cost to providing your product and/or service. Most businesses are not fortunate enough to be able to collect payment in advance, which requires floating the cash necessary to pay your suppliers, employees and operational expenses until such time as you can collect payment from your customers. How much and how long varies widely based more factors than I can list here but this is another area where a little can go a long way.
Review your payment terms with all your vendors to see if you can negotiate more favorable payment options with them. Generally speaking, longer payment terms with no discount will be more beneficial to your cash flow than getting a discount for paying early (yes, discounts are great but not if it means you have to shell out $100,000 a month or two early). Some suppliers have consignment programs that allow you to hold inventory at no cost until you sell it. You may be able to negotiate extended terms for all of your purchases. If you make large purchases for projects, pre-season orders or other special circumstances, you may be able to get your suppliers to work with you on these as well. Remember, everything is negotiable.
Be sure you also keep a good focus on inventory management. Buying large amounts of inventory can be very expensive, especially if you don’t buy it at the right time. Sitting on tons of inventory because it was brought in early will put a hurt on your cash flow very quickly. Turn your inventory as quickly as is practical and monitor its overall performance.
Your Pricing or Margins Are Too Low (probably both)
Common sense would dictate that the higher your gross margins are, the more cash will be made available to fund operations. Ergo, pricing and margins should be high on your list of things to review and manage. Most businesses, at least in my experience, get stuck in the idea that pricing is driven by the market. This couldn’t be further from the truth.
Customers don’t care about price. Customers care about value.
Read that again and think about it for a moment. While every business faces competition, if you can differentiate yourself and your product by adding value, pricing is much less of an issue. If you are unable to charge more than your competition due to your product or service being a commodity, then I would strongly encourage you to find a way to de-commoditize your offering.
All things being equal, higher prices result in higher margins but don’t forget to focus on your cost to serve as well. Managing direct expenses like cost of goods sold, freight expenses and labor to process orders can help you pick up a point or two on your margins.
You’re Not Forecasting Your Cash Flow Needs
To succeed at anything, you need to have a plan. To develop a solid plan to meet your cash flow needs, you need to forecast what those needs will look like. Unless you have some strong financial skills, this may be a better task for your accountant. Forecast your cash flow needs for the next quarter, taking any special circumstances or events into consideration. No forecast will ever be perfect but a good one will get you close enough to plan in advance what you’ll need to do to keep things afloat.
You’re Growing Too Fast
Rapid growth is a great problem to have. Wouldn’t we all like to be able to say that we’re selling too much stuff? Of course we would, but this can be a major problem, especially if you operate a capital-intensive business with long cash flow cycles.
In a perfect world, your business can self-finance its growth with profits generated from the business. Often, this is the case. However, if your business is growing rapidly there’s a better than fair chance that your needs will outpace your cash flow. This makes it necessary to secure an outside source of funding such as personal funds, one or more investors or a bank line of credit. This may or may not be a viable option for you. If it is, be sure that you’re willing to commit to giving up equity or incurring debt to continue at the same pace.
Even if you cover your financial needs, consider what type of operational resources it will require to maintain the levels of service your customers expect. In my experience once again, far more businesses fail from growing too fast than from growing too slowly. As such, another option is to strongly consider reducing your rate of growth. You can do this by being more selective with the orders you take, by marketing less aggressively, by raising prices to “throttle” your rate of growth (my personal favorite) or by myriad other options. Whatever you choose to do, make sure you that have a plan.
Cash flow is the life or death of a business. Every entrepreneur will face this challenge and many more (see our 8 Survival Tips To Succeed As An Entrepreneur). What’s important is making sure that you have the tools to address it.
Photo Credit: stevepb