It does not matter which corner of the world your business is located in, the causes of your cash flow problems are similar to what many other businesses are encountering.
From a sustainability standpoint it is essential that a business is generating positive cash flow every year. It is next to impossible to maintain the growth of your business, if you are not earning profits as well as generating surplus cash flow.
Many business owners in the past have considered cash flow issues as the cause of their issues rather, it should be considered as a symptom of deeper yet undetected management problems.
How to Detect Potential Cash Flow Issues
You can consider the following as signs that your business is dealing with cash flow problems:
- Non or late payment of invoices, disregarding of direct debits, employee superannuation and delayed payment of taxes.
- Late or non payment of employee wages.
- If legal notices are issued to your business by the HMRC or vendors/suppliers, it is indicative of severe/crippling cash flow problems.
If you have observed any of these warning signs, it is time to take immediate corrective action to address your business’s current cash flow problems.
Let’s now take a look at the three major causes of cash flow problems for a business.
1. Declining Gross Profit Margins and/or Sales
Declining Sales
Even a marginally small reduction in your sales targets can have a devastatingly cascading effect on the cash flow of your business. Profit margins could suffer because of increased competition locally or internationally, overall deterioration of economic conditions, or if your industry in general is suffering from decline.
Reduction of sales, coupled with a near constant amount of overhead will mean that your profit margins go down, which in effect will lead to cash flow problems for your business.
Declining Gross Profit Margins
Any reduction in your business’s overall gross profit margins will have a similarly destructive effect on your cash flow as even a marginal deduction in profit margins can lead to a significant dip in your profitability. Such a situation is usually the result of inadequate sales.
2. Is your Business Unprofitable?
Put simply, your business expenditures are significantly greater than what you’re charging your clients/customers for your products or services. For example, you are charging a client £1000 pounds for a product/service even when it is taking you up to £1050 pounds to fulfill the order.
This means that for every £1,000,000 your business earns, you are spending roughly £1,050,000, earning a net loss in the process. Ultimately as you keep accruing losses, you will be forced to raise additional capital just to keep your business afloat. But such a strategy will help you keep your head above water for only so long, especially if your keep incurring losses.
At this point you will have to either shut down your business or sell it off to a competitor. The bottom line is this-either you liquidate the business or someone else will do it for you (for example, the HMRC).
However, you could potentially salvage the situation by taking immediate corrective action. You could restructure your business in a way that it once again generates strong revenue streams and sustainable profits. You might have to consult an experienced turnaround specialist to help you achieve this.
Common causes of inadequate profitability include:
- An unsound business model.
- Important aspects of your business are underperforming such as sales, marketing or operations.
- Insufficient understanding about important financial documents pertaining to the business.
- Lack of timely and accurate financial statements.
- Insufficient number of Key Performance Indicators (KPI’s) or not monitoring them strictly.
- Poor employee productivity which directly contributes to underwhelming overall performance.
- Implementation of faulty processes or other errors/defects.
- Poor inventory management.
- Excessive overheads.
- Undisciplined spending.
- Implementation of a poor debt collection process which lead to a number of bad debt collection experiences.
- Bad credit approval rate of clients/customers.
3. You have Implemented a Negative Cash Flow Business Model
The following are all examples of a negative cash flow model:
- You are selling your products on 30, 60 or maybe even 90 day credit terms, but in the interim you have to manage expenses related to payroll, overheads and rent weeks or months before you will be repaid by your clients. Additionally, it is possible that credit terms offered to you by your vendors/suppliers are much shorter than the generous terms you extended to your customers.
- You have imported your stock and have paid for it weeks or months before it is expected to land in your warehouse.
- You are paid at certain progress points of a project and you have extended credit for these payments, which means that you will receive the payment way after you have paid off your contractors and other factory expenses.
There are many ways to address each of the situations mentioned above, but nearly every solution will involve a redrafting of your current business model. You can also raise extra capital by first figuring out how does cash flow finance work?
Make sure that you detect potential cash flow problems early and initiate appropriate remedial actions to safeguard the future of your business.
Watch this space for regular updates in the Hacks category on Running Wolf’s Rant.
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