Last week, we talked about why so many small businesses fail. Today, we are going to focus on a major reason: Poor Cash flow Management. According to U.S. Bank, 82% of small businesses fail because of cash flow problems. In other words, many businesses do not fail because they are not making sales—they fail because they run out of cash when they need it most. Let us look at why this happens and how you can avoid it.
What is Cash Flow, and Why Is It Important?
Cash flow is the money moving in and out of your business. Positive cash flow means you have more money coming in than going out, which helps you cover expenses like rent, payroll, and supplies. Negative cash flow happens when more money is leaving your business than coming in. This can be dangerous because, even if your business is profitable, you might not have enough cash on hand to pay bills on time.
Common Cash Flow Mistakes:
1. Late Payments from Customers: Many small businesses struggle to get paid on time by their clients. A survey by QuickBooks shows that 60% of small businesses face issues with late payments, and some clients take up to 90 days to pay their bills. This can cause serious cash flow problems if you are waiting months for money that should be in your account.
Tip: Make it easy for clients to pay you by sending invoices right away and setting clear payment terms. You can even offer small discounts for early payments or charge late fees to encourage clients to pay on time.
2. Overestimating Future Sales: It is easy to be overly optimistic about how much you will sell in the future. But if your sales do not meet your expectations, you could end up spending too much too soon and running out of cash.
Tip: Be realistic with your sales forecasts. It is better to plan for a slow month and be prepared rather than assume sales will be great and fall short.
3. Not Having a Cash Cushion: Every business faces unexpected costs, whether its equipment breaking down or needing extra stock. The JPMorgan Chase Institute found that the average small business has only 27 days’ worth of cash reserves—not enough to survive a big emergency.
Tip: Aim to build up savings that can cover at least three months of expenses, so you are not caught off guard when something unexpected happens.
4. Paying Bills Faster than You Collect Cash: Many businesses pay suppliers before they get paid by customers, which creates a gap in cash flow. For example, you might pay suppliers weekly but only get paid by clients once a month.
Tip: Try to negotiate longer payment terms with your suppliers or ask clients to pay sooner to close the gap.
5. Not Using Tools to Track Cash Flow: Tracking cash flow manually can lead to mistakes, and 44% of small businesses do not track their cash flow regularly, according to Intuit.
Tip: Use bookkeeping software like QuickBooks or Xero to automate tracking. This will help you see where your money is going and coming from, making it easier to manage.
Identifying Early Warning Signs of Cash Flow Issues:
Spotting cash flow problems early can be the difference between staying afloat and going under. Here are some common red flags that indicate your business might be heading toward a cash crunch:
1. Constantly Worrying About Paying Bills on Time: If you are frequently stressed about whether you will have enough cash to cover your bills, it is a sign your cash flow is too tight. This can lead to a cycle where you are always playing catch-up, potentially hurting relationships with vendors or creditors.
Tip: Create a cash flow forecast to plan out your expenses and income for the next 3-6 months. This will give you a clear picture of when you might face cash shortages, allowing you to take preemptive action.
2. Relying Heavily on Credit Cards or Overdraft: Using credit cards or overdraft to cover basic operating expenses is a major red flag. While these can be helpful tools in a pinch, regularly relying on them to pay for day-to-day operations means your business is not generating enough cash to support itself.
Tip: Instead of relying on high-interest debt, try to build an emergency cash reserve. Aim to save enough to cover at least 2-3 months of essential expenses like payroll and rent.
3. Struggling to Meet Payroll: If you find yourself scrambling to pay employees, it is a sign that cash flow is out of balance. Delaying or missing payroll not only affects your employees but also damages morale and can lead to retention problems.
Tip: Prioritize payroll when managing cash flow. If you anticipate a shortage, explore options like a short-term line of credit or negotiating payment terms with suppliers to free up cash for payroll.
4. Frequently Delaying Payments to Suppliers: If you are pushing back payments to suppliers or negotiating extensions to buy more time, it can signal a deeper cash flow issue. While delaying payments can give temporary relief, it can harm supplier relationships and may result in lost discounts or supply disruptions.
Tip: Open communication with suppliers is key. Rather than avoiding payment, work with them to arrange flexible payment terms or installment plans. This can help maintain a good relationship while giving you breathing room with your cash flow.
How to Improve Cash Flow:
1. Speed Up How You Collect Cash: Your goal should be to get paid as quickly as possible while paying your own bills as slowly as you can (without getting charged fees). This is called shortening your cash conversion cycle. Find ways to collect customer payments faster, move products more quickly, and delay payments to your suppliers when possible.
2. Create a Cash Flow Forecast: A forecast helps you predict when cash will be tight and when it will be flowing well. By doing this, you can plan ahead for slow periods and make smarter financial decisions.
3. Negotiate Payment Terms: Talk to your suppliers and clients about changing payment terms. For example, if you can extend your supplier payments from 30 days to 60 days, you will have more time to collect money from your customers before paying out.
4. Adjust Pricing or Cut Costs: If you are constantly struggling with cash flow, consider raising prices slightly or cutting some unnecessary expenses. Even small changes can make a big difference to your bottom line.
Managing your cash flow is about more than just having enough money in your account today—it is about making sure your business can survive tomorrow. By keeping a close eye on your cash, making smart adjustments, and using helpful tools, you can avoid the cash flow pitfalls that cause so many businesses to fail.
What cash flow challenges have you faced in your business? Share your thoughts in the comments, and do not forget to follow along for the next article, where we will explore the importance of a solid business plan for long-term success.