Cash flow is critical for businesses, so cash flow management is key. Here's how to improve your business's cash flow situation.
In business, cash is like oxygen. A business without money on hand is usually doomed to suffocate. That means managing your cash flow is critical to the survival of your business. Unfortunately, many businesses experience common cash flow issues that make it harder for them to operate. This guide will help you understand cash flow management more clearly and identify key cash flow issues you should do your best to avoid.
What is cash flow?
Cash flow refers to the total amount of money flowing in and out of a business. It encompasses all the revenues and all the expenses of a business at a given moment in time. Cash flow management means planning your inflows and outflows accordingly to ensure your business always has cash on hand.
Why is cash flow important?
Cash flow management is important because without liquid capital on hand, businesses cannot pay wages and other bills on time. It also means delaying any equipment purchases or new acquisitions. In some cases, lack of liquid cash can lead businesses to expensive financing options that leave them in debt, increasing expenses in the form of debt service.
Having money in the bank is key. A profitable but cash-poor business could ultimately run into significant issues that cut into profit margins or, worse yet, eclipse profitability altogether. Poor cash flow management leads to much bigger issues for a business that, if left unaddressed, can rapidly snowball into a giant problem.
Don't let these cash flow issues happen to you
Poor cash flow management is the No. 1 reason small businesses fail. In fact, 82% of small businesses fail because of cash flow problems. Managing your cash flow properly takes time and energy, but it's imperative to understand where your cash is coming in and how it is leaving.
As you tighten the reins on your finances, watch for these seven common cash flow problems that can severely impact your business.
1. Late payments
Late payments are one of the main causes of cash flow problems for small businesses. Small business owners typically operate with tight budgets and rely on payments being completed on time in order to pay bills and scale. In reality, the majority of clients will pay late. It's estimated that small business owners wait 72 days on average for payment on invoices. Waiting over two months for payment can put your business in danger, especially when you're relying on cash for growth.
A great way to avoid late payments is to get up to speed on the best practices for billing. A great start is to use cloud-based online invoicing software for all your billing needs. There are plenty of online payment solutions that provide invoicing tools optimized to get your bills paid on time. These solutions give you the means to accept multiple forms of payment, follow up with clients, and easily access your invoice records and reports. [If you need help with your invoices, check out our pick for the best online invoicing software.]
2. Lack of profitability
Only 40% of businesses are profitable. Additionally, only 30% will break even, and the other 30% actually lose money. Lack of profit tends to be one of the main reasons why companies fail.
While there is a correlation between poor profitability and cash flow problems, issues can still arise for companies that are making a steady profit. If your company has high business expenses and is constantly looking to reinvest profits, you need to be extra wary of cash flow issues. Plenty of companies have gone under, despite raising millions of dollars, owing to the simple fact that they were unable to generate steady cash.
The best way to avoid these issues is to always be on the lookout for profit-making opportunities. These include new products or services, product markups, consulting work, and discount and deal offers to increase your traffic.
3. Withheld investment or funds
Locking in an investment or a loan to fund your business is always a great feeling. However, it has some rather serious contingencies. If you don't meet expectations or your income is much less than you projected, an investor or bank can withhold a portion of your funds. This can become a huge cash flow issue, considering you likely rely on those funds to cover major expenses until you can generate extra cash. This is especially alarming in the event of an emergency, such as a piece of equipment breaking, resulting in a large capital expense for your business.
The best way to avoid this problem is to give yourself a bit of breathing room. When you initially ask for a loan or seek investment, always ask for 25% more than you "project" as well as a line of credit. This way, you can cover yourself in an unforeseen event or emergency.
4. Tax filing
Whether you're a monthly, quarterly or annual tax filer, it's your responsibility to file the correct amount of taxes on time. Tax filing itself isn't a cash flow issue; however, if you don't file correctly or on time, it can be extremely detrimental to your business. If you file late or incorrectly, you are subject to interest payments, penalties and even an audit from the IRS. Not only are these penalties and fees expensive, but they take up tons of valuable time that could've been spent scaling your business.
The best way to avoid these issues is to stay on top of tax deadlines and consult a tax specialist. Most business owners are busy enough as it is, so it's a good idea to delegate tax work to a professional. A tax specialist will help you not only to prepare and file your taxes on time, but also to find potential tax deductions.
When tax time comes around, make sure you have enough cash in the bank to pay them off. While you may not have the exact dollar amount, you can build a basic model based on last year's taxes versus your growth for the current year.
5. Undervalued products or services
As a business owner, you should understand the value of your product or service and set your pricing accordingly. You might worry that raising your prices will turn people away, but this isn't necessarily true. Increasing the cost of your product or service also increases its perceived value, which could bring in more customers. If your prices are too low, people may perceive your product as less valuable or of lower quality. However, setting your prices too high means you could lose out to competitors offering better rates.
To maximize your profit, you'll want to find a happy medium: high enough pricing to increase your cash flow and establish your business as valuable, but not so high that you lose out on potential sales. Conducting your own market research can help you determine the exact price point for your company.
6. Scope creep
"Scope creep" refers to when a project's requirements unexpectedly change or increase over time. It's an all-too-common phenomenon that isn't necessarily a bad thing, but you'll want to be aware of it and manage it appropriately. Your awareness of scope creep can not only ensure you're being compensated fairly for your work, but also prevent you from incurring additional costs.
Whether your product is sold with any conditions or your services are outlined in a contract, you should know exactly what is expected of you at the outset. If those expectations change and you're given additional work, you should seek out compensation for your time and any associated costs. Failure to do so means that not only are you being paid less for the amount of work you've completed, but your costs could potentially increase as well.
7. Use of old equipment
Old equipment not only takes up valuable space but is also inefficient. Constantly replacing equipment can be costly and frustrating, especially as technological advances continue to render older product models obsolete, but keeping up with the newest equipment helps your business to run optimally.
Leasing your devices can be a cost-effective method of staying modern: Not only will you always have the latest technology at your fingertips, but newer models tend to be more power-efficient. In some cases, selling old equipment can also result in taxable gains.
Final thoughts on cash flow
Regardless of the size of your business, managing cash flow can be quite stressful. However, solving your cash flow issues doesn't have to be all that difficult. If you take the necessary precautions and remain educated on your specific cash flow needs, then you're on the right track. Keep these seven cash flow problems in mind to help you avoid them at all costs.
Renzo Costarella contributed to the writing in this article.