A cash flow problem in business is when the cash coming in no longer outweighs the cash going out. Your organisation starts to stagnate, or worse, lose money. This lack of liquidity can eventually lead to insolvency.
The good news: Cash flow problems are also exceedingly manageable, even predictable.
It all comes down to knowing the common causes, staying prepared, and getting a system in place to prevent or solve any cash flow problems as they arise. So let’s dive right in.
The effects of cash flow problems on a business
It’s easy to mistake sales for cash flow. Money is still coming in, so we must be fine, right?
But sales don’t always equal money in the bank. When all your cash is tied up in managing inventory, overheads, unpaid invoices, and operational costs, you wind up with nothing left to pay the bills. That’s when the snowball effect begins.
Here are some common effects of cash flow problems on a business:
- Hamstrung growth: Without cash in hand, the organisation can no longer expand its products, customer base, staff, premises, and so on. There’s no money to make new investments, leading to missed opportunities. Growth slows, halts, or reverses.
- Restricted flexibility: A lack of cash flow can lead to poor agility, particularly in times of economic strife. Sudden changes in operations (moving to remote work or changing business models to suit a new market) generally require a cash buffer to keep the business thriving while productivity drops.
- Indebtedness: Every business must balance its operational costs with paying back its various loans. Reduced cash flow may mean that you must choose between one or the other, potentially leading to increased debts and harsh late payment fees.
- Staff morale: Staff can sense when a business is struggling, and while this can sometimes lead to people pulling up their socks and sticking together, it can also lead to lower morale. This is especially true when wages are paid late.
- Customer satisfaction: Unhappy staff rarely put in the same effort to delight customers, and a lack of extra cash could mean you’re unable to keep up the same production efficiency as you once did.
- Reduced marketing budget: Your marketing budget is essential to getting more customers in the door, but if the business starts to struggle then this may need to be cut. Less marketing could lead to fewer customers, and in turn, further cash flow problems.
- Insolvency: The absolute worst-case scenario is that the business must be wound down entirely, unable to pick itself back up. Insolvency is the last-resort option when it comes to fixing cash flow problems.
They say prevention is better than cure – with that in mind, let’s explore some of the common causes of poor cash flow.
10 common causes of cash flow problems in a business
Cash flow problems can be a major headache for business owners and their accountants.
But by being aware of what to look out for, you give yourself a better shot at making the right decisions early on. Below are 10 common causes of cash flow problems you should avoid.
1. Late, or lack of, invoice payments
Some business owners count their income as they send the invoice, but the reality is that income isn’t income until it hits your bank account.
Cash tied up in outstanding receivables is one of the biggest cash flow problems you can have. According to Xero’s figures, almost half of all invoice payments made in 2021 to small businesses were paid late. And if payments are late, it means your ability to invest in yourself gets delayed and you may miss opportunities.
2. Shrinking profit margins
Get your pricing wrong and you could hamstring cash flow without ever realising it.
Profit margins can shrink for all kinds of reasons, and two of the most common are product-related: pricing your products too low, or not selling enough high-value products. It can also be an indicator that costs are too high, which we’ll get into below separately.
3. No cash buffer
If you have a solid cash reserve sitting in the wings, your business will be a lot more adaptable to the changing market. The reverse is also true: Less money available in your reserve can cause serious friction during times of change.
Unfortunately, most small businesses don’t have good cash reserves.
The US Federal Reserve Bank found that 86% of small businesses would be forced to find new funding or trim expenses if faced with a two-month revenue loss. 47% of those business owners said they’d have to dip into their personal bank account to supplement the business, and 17% said they’d have to close.
4. Underestimating costs
Time and again we’ve seen that brands face cash flow problems because they just … got things wrong. Their predictions were all off, and income was lower than expected.
Sometimes this is out of your control. Markets change, inflation happens, materials become scarce.
If your forecasting isn’t accurate, you’ll end up with too much stock that you can’t get rid of, pull in more staff than required for a quieter period, or any number of related issues – all of which can lead to higher-than-normal business expenses.
5. Too much growth
Growth is good. But too much growth? Potentially not.
Business growth can mean more money coming in, but too much business growth can lead to more money going out. Higher overheads, increased debt, the need to invest in new assets or staff, handling more inventory – it all comes at a cost.
If you focus too much on potential profit and not enough on real, bottom-line cash flow, you may miss the tipping point in all the excitement.
6. Messy bookkeeping
Business research papers have been drawing lines between good accounting practices with small business growth for decades.
The reason for this is simple: Good bookkeeping and good business health are intrinsically linked.
Cash flow is at the heart of this connection. With disorganised accounting practices, you could dip into the red without even realising. You might see the money coming in as healthy, without seeing all the money going out. Especially hidden costs, like subscription fees, overheads, and insurance premiums.
7. Unhealthy debt
Every business owner knows that loans are a double-edged sword. They can provide much-needed capital at a time when it’s opportune to invest, but they’re also a cost which must be managed.
If you’ve borrowed too much, or your loans are particularly expensive, these costs may outweigh any benefits from the initial loan.
Unfortunately, loans can also start a bit of a cascade. High debt leads to poor cash flow, leads to trimmed budgets, leads to unhappy customers and reduced income, which in turn leads to late repayment fees … the cycle has no end.
8. Too much inventory
There’s a certain hoarder mentality in some of us which tells us it’s a good thing to have lots of stock on hand, so we can sell when the time is right.
But every item held in inventory costs money.
Storage overheads, staff, shrinkage, spoilage – the more inventory you keep around the more these build up.
Eventually, there will come a point where you simply have too much, and you can’t clear it out quickly enough to recoup the losses, leading to cash flow problems.
9. Mismanaged expectations
As you start a new business, join a new market, release a new product, or just generally get excited about what you’re doing, it’s easy to let your expectations of profit run wild.
But profitability takes time. If you don’t manage your expectations, you can end up spending cash you haven’t yet earned on more stock or business growth and have none left to pay the bills.
10. Changes in customer demand
This one is out of your control, but it happens, and you have to be prepared for it.
Whether it’s because the season changes, a new fad comes or goes, a competitor knocks your product off its pedestal, or the entire economy gets turned upside down – customer behaviours and desires are always shifting.
Sudden changes in demand can have drastic consequences when it comes to cash flow. If this is coupled with a lack of cash reserves as mentioned above, it may lead to poor business adaptability and troubled waters for the company.
How to solve common cash flow problems
If cash is king, cash flow is the kingdom.
A king is only a king so long as citizens pay their taxes. Likewise, a business can only keep doing business so long as there is cash flow to support it.
Sometimes it’s too late to prevent cash flow problems; sometimes you’ve just got to clean up the mess. The following tips are designed to help you tackle your cash flow problems head-on.
1. Revisit your business plan
If you’re worried about cash flow, it won’t hurt to go back to the drawing board for a quick revision.
This is an opportunity for you to break your organisation back down again into its core processes. Examine your people, operational expenses, sales predictions, and the current market to figure out where your biggest wins and losses are happening.
Chances are it may have changed since you started.
2. Create better business visibility
Good organisational visibility is key to stemming the loss of cash flow due to problems like too much inventory and slow-moving stock. Invest in a system that gives you a big-picture view of your company.
Inventory management software can help you plot out and cost the entire production pipeline from the supply chain through to freight. Comparing the data from your various processes will help to determine your Cost of Goods Sold (COGS), reduce inventory costs
3. Get better at forecasting
Forecasting is one of your biggest allies when it comes to preparing a business for a changing market.
While you can’t predict every little problem that might pop up, you can prepare for most. Invest in software or an accountant that can ensure accurate forecasting across your inventory and purchasing needs. Seek to identify seasonal trends, sales patterns, and warning signs.
If you know what’s going to happen next, you can ensure you have the right amount of inventory and staff on hand – whether that means scaling up, or down.
- Learn more: Inventory Forecasting Explained: The 2022 Guide
4. Manage your profit expectations
Before making any big decisions about your business, sit down and do some thorough research.
Try your best to take emotion out of things and focus on making rational, logical, thought-through decisions backed by research. It’s easy to get excited when your sales numbers start growing – but don’t let your enthusiasm influence your choices.
It’ll help to have data; collect information about the business as well as from wider market research. Data is evidence, and evidence is key to smart decision-making.
5. Minimise expenses
If you’re predicting an expensive season to come, it may be time to trim the fat.
Here are some quick ways to reduce your business expenses:
- Freeze any pet projects
- Cancel any ‘nice-to-have’ subscriptions or services
- Negotiate better prices from suppliers (or procure new suppliers)
- Refinance or consolidate multiple loans into one
- Eliminate unnecessary operational costs and sell useless equipment
- Minimise your overheads by getting quotes from multiple service providers
6. Get good accounting software
Accounting software provides visibility over your numbers, making it paramount to maintaining good cash flow.
Cloud-based software like Xero and QuickBooks is designed to make accounting easy and fast. Look for one that integrates naturally with your inventory management software, so that the data from one automatically feeds into the other.
When all your data is synced between the different areas of your business, you’ll have a clearer image of your profit margins and production costs.
7. Try not to overextend
The aim should generally always be to grow, just not too quickly.
To avoid growing too fast and running out of expendable cash, get a growth plan in place.
Your business growth plan should answer:
- What are your cash flow KPIs?
- How will you expand within your market? Will you move into a new one?
- Will you need new premises or new equipment?
If you think your potential growth is worth some short-term cash flow problems, plan for it. Identify which expenses can be trimmed, which financial institution offers the best terms for a short-term loan, and how much of your ‘safety cash’ buffer you can afford to dip into.
8. Try to get paid quicker
One of the best ways to shrink your cash flow problems is to ensure cash is never tied up too long in late receivables.
This relies on having good partners who pay on time in the first place, but there are a few things you can do to help.
Here are some quick tips for getting paid faster:
- Don’t delay invoicing customers.
- Keep good records so you can track the status of your invoices and due dates.
- Be prepared to chase invoices by any method necessary: email, phone, or even court.
- Make it easy for your customers to pay by accepting multiple payment methods.
- Break up large invoices into smaller instalments.
- Cease activity with an owing customer until their invoice is paid.
- Incentivise early payments with discounts or bulk deals.