No one is immune to cash flow crises. Some are unforeseeable while others can be planned for. If cash flow problems put an end to even the most successful of businesses, why do cash flow problems occur? Many business owners have a hard time figuring out what’s behind their cash flow problems, but there are only really a few principal reasons for cash flow problems: Your money is either:
(1) not coming in because your customers don’t pay or slow sales growth;
(2) tied up in receivables, inventory or overhead; or
(3) your gross margins are off (prices to low and costs too high).
Each of these areas has specific causes and manifestations which we’ll uncover in this section. You’ve probably heard or read about some of these, but right now you are going to get in one place all the “cash flow killers” or reasons why cash flow can become a dream-killing problem for businesses. In order to solve your cash flow crisis in the quickest and most appropriate way possible, it is necessary to pinpoint the precise cause of the problem. Understanding the factors that can steal your business cash flow will not only help you to identify the source of cash problems, but will help you craft the right mix of solutions to solve your cash crisis in the short to long term and making sure you never have a cash flow crisis again.
So let’s take a closer look at the common categories of cash flow killing problems. We call them CTM. It’s a useful shorthand for any business experiencing significant problems with cash flow. When cash is a problem the first thing you have to check is if your CTM is out of whack. What does CTM stand for?:
A. Money is not Coming in
B. Money is Tied up
C. Money is not being Made
If you need a pneumonic phrase to help you remember, call it “Cash Terminating Mistakes” or, more proactively, “Cash Transaction Management.” That will help you to remember the key principles that are necessary for your business to survive.
But wait, maybe you never had enough money to start with and have been operating in the red from day one! For your business to survive in the long run, you need enough finance from investors, savings and credit to take you through your first couple of years (start-up capital) and beyond (working capital). Once you have enough operating capital, the trick is to get more money, accelerate the receipt of cash, and hang on to it as long as possible. Loans are one way to help you manage the process.
If you are generating cash on paper, but cannot figure out why you never have enough to pay your obligations, or you are generating too little cash then read on to find out what are the 12 biggest cash flow killers and why they occur. We’ve divided them into the three C-T-M categories mentioned above.
Cash Flow Killer Category #1
C = Money not COMING in
This is when no new money is coming in, either because of weak sales growth or bad debt.
Sales (or the lack of them) are at the heart of poor cash flow. Without strong slaes growth, the amount of incoming money you have is less as well as your liquidity. Many things can cause a slump in sales, such as staff performance or size and your product mix. In addition, if you are operating beyond your capacity because you’ve taken on new work, you may not be devoting sufficient time to attracting new clients or making sales.
If you sell products or provide services tied to a particular season, then your sales during the boom time period must carry you through the leaner months.
This is when you are unable to collect your receivables because your customers fail to pay. You may also be spending excessive amounts of money or time (same difference) to collect payment. The reverse may also be true, you may have no time available to focus on chasing down bad debt. If any of these problems are the case, they will impact your cash flow and you’ll need outside help to track down this debt or decide whether to sell it off.
Cash Flow Killer Category #2
T = Money is TIED up
This is when your money is tied up in receivables, inventory or overhead.
Problems Collecting Receivables
Any profits you calculate are only on paper until you collect payment from your customers. While extending credit to too many customers is one thing, other factors can slow down the flow of cash from customers to you. Are you slow to finish projects because you are short handed or not operating efficiently? You can’t bill clients until after the job is finished. You also have to be clear about what your deliverables are so that you and your clients actually agree on when the project is finished so that you can bill for your services or goods provided.
Maybe you start on projects with no capital specifically available to start new work? This can happen when you don’t collect deposits from clients (this is similar to the problem of extending credit excessively).
Other common problems include extended billing cycles (reduce the time between finishing a project and billing your client) or outdated methods of payment collection. Do you only accept checks and not credit cards? You are building in delays to receiving your money. Another issue is clients who pay late or not at all (see Bad Debt under T below).
Too many Debtors
Do you extend credit to all your customers? What about your biggest customers? Many large firms who are big accounts abuse small businesses by delaying payments knowing that the small business won’t dare demand payment for fear of antagonizing the relationship. When your customers don’t pay you on time, your cash flow can get wiped out, especially if the amount owed is a large amount. This can have a snowball effect, where the lack of such a large amount of money coming in prevents you from carrying out your business or incurring more interest resulting from additional loans or credit taken out to cover the delayed payment.
Too many Creditors
This is a case where you are not able to hold onto your money long as it is going to too many different parties. Credit is positive, as taking advantage of creditor terms can keep cash in your business for a longer period of time. The problem occurs when you also have a lot of clients that your business extends credit to. You may have to wait for them to pay in order to pay your creditors.
The more accounts you have can compound the number of late fees or delinquent charges when late or missed payments occur.
When it comes to being overly financed, it’s common for start-ups to borrow a lot to finance a business. The problem is that each credit account means more interest, more scheduled payments, and less control over your business. The requirement that new businesses, even incorporated ones, use personal guarantees (house, business equipment and assets) means that the more you borrow the more your personal and business assets are at stake. Moreover, late or missed payments can also increase the number of negative marks on your credit report, increasing your interest rates and reducing your access to credit.
Another mistake many businesses make is to tie up their startup or working capital in a lot of physical assets like vehicles, machines, office equipment, facilities. Excessively tying up money in expenditures outside of direct labor and raw materials could be hurting your cash flow. Buying these things outright as a new business can lead straight to failure. It is more important to have cash on hand of the unexpected such as the need to repair equipment or vehicles, tax assessments, unexpected interest rate changes, and so forth.
Excess inventory of raw materials or finished product and storage costs will tie up your capital. “Unproductive assets” is the official term and is sometimes cuased by unofrseen drops in demand. Other times poor market research results in bad decisionmaking around inventory control. The tough thing is that cash is harder to come by for sole proprietor small businesses than for corporations, so inventory must be watched carefully. Too much inventory can be just as bad as not enough (when you cannot fulfill orders in time to generate new receivables). Balance is key which means carefully paying attention to your business.
Cash Flow Killer Category #3
M = Money is not being MADE
This is when your gross margins are zero or negative because your prices or costs are out of whack.
When your prices are too low, or your direct costs too high or a combination of both, your cash flow will be hurt.
Personal use of business funds
Keep your business and personal cash and bank accounts separate. A lot of small business owners get in big trouble this way.
The Lack of Funds to Cope with Unexpected growth
This is a biggie. The cash crisis because you’re too successful too early! It occurs because you’ve over-promised or over-sold your goods or services relative to the cash you have to fulfill the order. It’s natural to want to accommodate increased demand for your goods and services, but you have to think about not only whaqt you will earn from each sale, but how much does each sale cost you? If you have over-sold goods or services AND extended credit to the client, this can lead to disaster. This is true for service businesses and physical product-based businesses alike.
Imagine you are a janitorial services firm with four workers. Your firm doesn’t have a line of credit or a lot of cash on hand. One of your clients asks you to start a new, large job in a couple days in addition to what you currently do for them. It’s more money and you consider it a break. Of course you say yes. The additional job will require you to hire and transport eight more workers, obtain new floor machines (carpet cleaners, floor strippers, scrubbers, vacuums) upholstery tools, chemicals and supplies.
To supervise your new workers and make sure the job goes well, you have to promote one of your current workers on the old job. You have to keep equipment onsite for the duration of the new job. Some of your new workers may not show up, causing you to move some from the old site to the new site to ensure the client is confident in your ability to take on additional work.
Other unforeseen problems in the new location, such as delays in accessing locations may delay you, resulting in additional equipment and labor costs. You may decide to take on additional workers to make sure you can finish the job on time despite absences and other delays. You may realize that you have been doing all administration and not doing any work yourself, meaning you decide to hire an administrator. To top it off, you may have to wait for six weeks after the work has been completed and bills to receive payments. The following week, the client is so pleased with your work on the second job they offer you a third job! Woohoo! That’s great, right? Right?!
The same can occur with additional product orders. You will need resources to order or manufacturer and deliver your product. Where will the cash come from to take on an additional sale? What if all this new business is being generated by one customer that represents 75% of your sales income? Not taking on additional work may mean losing the client altogether as they seek out a firm that can meet their needs. Taking on the additional work or orders may mean the end of your business. It may seem like an oxymoron, but rapid growth can kill small businesses.
Would you like an easy way to diagnose all your cash flow problems and the full range of solutions at your disposal? Check out our free cash flow problem and solutions mind map. This handy tool is yours free just for signing up to join the PowerAchievers.com community.