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How to Avoid a Cash Flow Crisis: Know Your Business
No one type or size of business is immune from the plague of cash flow problems. While they are most likely to strike a younger business when management is more prone to underestimating its sales-cycles or collection time-frames, all businesses become susceptible when the economy unexpectedly down-shifts, exposing them to sudden shifts in demand. Small businesses, especially, bear the brunt of the cash flow problems of their corporate clients who decide to unilaterally extend their payment terms well beyond the standard 30 days.
For some business owners, the most haunting cash flow problem is the one that occurs with profitable businesses experiencing a growth spurt only to find that their cash flow can’t keep up with their increasing expenses. Similarly, businesses that expand rapidly often run into cash crunches because they let their accounts receivables get out of control.
The chances of surviving any of these critical business junctures are slim at best for businesses that take cash flow management lightly. Nothing short of a deliberate and disciplined process for tracking, analyzing and forecasting the business’ cash flow situation can ensure business survival, and, ultimately, business success.
Businesses need to Know When, Where and How Cash Needs Will Occur
Since small businesses tend to rely on their speed and flexibility to react to changing circumstances, keeping paper-based ledgers and records, or even a basic electronic spreadsheet would not provide the sort of information needed to make effective decisions. Small business owners need the ability to keep their finger on the pulse of their cash needs, and they need to be able to foresee when and from where their cash is going to come. With the technology available today, small business owners can have affordable access to the most state-of-the art cash management solutions.
Businesses need to Know the Best Sources for Meeting Cash Needs
Even the best managed businesses meet with unexpected expenses that can throw off their cash projections. A sudden business opportunity arises, the need to replace a key employee, the need to ramp up for a big contract, or the sudden loss of a contract, are unexpected occurrences that can put a long-lasting strain on cash flow. For many small businesses, finding a lending source may take too long, or they may not be able to qualify for a loan.
Getting control of cash flow and having the ability to project future cash needs and cash on hand, greatly enhances the position of business owners to know well ahead of time the sources available to meet cash shortfalls as they occur. For example, one method of raising immediate cash that has seen increasing application by small business owners is “accounts receivable factoring.” In essence, the business sells its invoices at a slight discount of three to ten percent, the idea being that it can collect at least 90 percent now, rather than having to wait 90 days to collect 100 percent.
Although it does seem like an expensive short-term loan, the business has cash in hand, while the third-party buyer of the invoices is tasked with chasing down the payments from customers. But, this approach, along with other creative uses of cash flow, can only work within a highly structured cash flow management system.
Other ways to raise capital quickly might include selling off slow moving inventory at reduced prices. Although, it would be important to let your customer’s know that the price reduction is only temporary. If your business owns equipment, you can arrange to sell it to a lender which, in turn, leases it back to your business, creating, in effect, a loan on equipment you own. Of course, you can sell unnecessary assets such as unused equipment, furnishings or space.
Businesses Need to Know How to Avoid a Cash Flow Crisis
Know your cycles: If you have seasonal needs - whether for more employees, more inventory or more capital - and those needs must be paid for ahead of receipt of payment for goods or services, build up sufficient reserves, or establish a line of credit ahead of time.
Know your debt needs:If you borrow money, make sure you can make payments based on current operations, not on unrealistic, “wishful thinking” company sales and earnings. If the growth you hoped for doesn't occur, you've got a problem - one that could potentially sink your company.
Know your inventory: Money spent on inventory is cash out until those goods are sold. If you purchase inventory on credit, it is important to have a good sense of your inventory aging and related accounts receivable so you're comfortable that payment can be made before it's due.
Know your cash management processes: Your receivables and payables management processes should be streamlined with use of electronic processing, automated billing and automated pay roll to ensure optimal inflow and outflows at all times.
Know your vendors, suppliers and clients: Often the first sign of trouble is a vendor that asks for accelerated payments or a client that delays payment. Always work on your relationships with vendors and clients so they can become effective partners during a cash crunch. Being able to negotiate new terms with suppliers or ask clients to pay more quickly can help your business survive a crisis.
Know your expenses: Although it may be an obvious solution, cutting back on the wrong expenses can worsen the problem.
Through effective, ongoing cash flow management, a business should be able to clearly understand its current needs while forecasting future trends, and plan accordingly. However, forecasts can’t always account for events that can abruptly alter the business’ trajectory, such as a sharp economic downturn, a disruptive technology, or a sudden market shift. The best way to avoid an unforeseen cash flow crisis is to thoroughly know your business, and all aspects that can impact its cash flow at any time.