Often you will hear that cash flow issues are the primary cause why many businesses close their doors. All other reasons of business failure must relate to cash flow issues before a firm goes bankrupt. Cash is the life blood of business because no business can survive without healthy cash flow. What are common causes of small business cash flow issues?
- Collection and Payment Period Mismatch – If you sale goods or provide service on credit, you need to ensure early collections of sales proceeds from your clients. This is even more important if your supplier are not selling to you on credit or offer a very short credit period. Example if your suppliers offers 30 days credit on purchases, you may have cash flow issues if you offer anything beyond 29 days to your credit sale customers.
In other to avoid such mismatch, you have to set a lower collection period compared to payment period, give cash discount for early payments or arrange a recurring overdraft line with your bankers.
- Insolvent Customer with Huge Debt – A firm that sells majority of its outputs to one client will experience cash flow issues if the customer is declared bankrupt. It is always advisable that managers monitor sales and credit concentration risk on one client or industry. For example you should not allow 40% of receivable to be outstanding with only one customer.
- Poor Working Capital Management – Working capital are the funds available for the day to day operations of the business. In finance it is the differences between the firm’s current assets and current liabilities. Current asset includes stocks, debtors, bank balance and short term liquid investments whiles current liabilities includes all short term liabilities like trade creditors, tax payable etc. If a firm have more short term obligations than short term expected cash flow, it can face liquidity issues if the gap is not closed.
- Poor Financial Planning – A plan is a set of goal with the mean to achieve it, whiles budget is a financial plan. A simple budget should list the firm’s expected cash inflows and cash outflows within a specific period. When a firm doesn’t prepares budget, chances are expenses cannot be properly controlled. Budget helps the firm to forecast potential cash flow issues. In fact, good planning and control avoid unnecessary unplanned expenses like buying brand new cars for the owner. I am not saying that the owners should not be buying cars, however there should be a plan to assess its impacts on the business cash flow.
- Buying too much of Stock – Small businesses may buy lot of stocks for reason of expected stock shortage or an increase in price and sometimes to enjoy quantity discount offered by suppliers . If such heavy purchases are not aligned with the firm expected cash flows, the business will be put under cash pressure. Goods can sometimes be cheaper in the market but buying too much stock can also tie cash.
- Diverting business fund – Many small businesses operates one bank account that is used for both personal and business transactions. This can sometimes be disadvantage, because many owners tend to eat into business funds without knowing it. However, some business owners also make mistake of diverting the funds of one business to an unrelated venture. The most serious form of diversion is the use of business funds on personal activities.