How to Avoid a Cash Flow Crisis: Know Your Business

No one type or size of business is immune to 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 downshifts, exposing them to sudden shifts in demand. Small businesses, especially, bear the brunt of the cash flow problems of their corporate clients, who often 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 encounter cash crunches because they allow their accounts receivable to become unmanageable.

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’s 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 often rely on their speed and flexibility to react to changing circumstances, maintaining paper-based ledgers and records, or even a basic electronic spreadsheet, would not provide the type of information needed to make effective decisions. Small business owners need the ability to stay informed about their cash needs and accurately forecast when and from where their cash will come. With the technology available today, small business owners can access affordable, state-of-the-art cash management solutions.

Businesses Need to Know the Best Sources for Meeting Cash Needs

Even the best-managed businesses encounter unexpected expenses that can disrupt their cash projections. A sudden business opportunity arises, the need to replace a key employee, the need to ramp up for a major contract, or the unexpected loss of a contract are all occurrences that can put a long-lasting strain on cash flow. For many small businesses, finding a lending source can be time-consuming, or they may not 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 may seem like an expensive short-term loan, the business has cash in hand, while the third-party buyer of the invoices is responsible for collecting payments from customers. However, this approach, along with other creative uses of cash flow, can only be effective 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 is important to let your customers 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 essential to have a clear understanding of your inventory aging and related accounts receivable, ensuring you’re comfortable with the ability to make timely payments before they are due.

Know your cash management processes: Your receivables and payables management processes should be streamlined with the use of electronic processing, automated billing, and automated payroll to ensure optimal inflows and outflows at all times.

Know your vendors, suppliers, and clients: Often, the first sign of trouble is a vendor requesting accelerated payments or a client delaying 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 seem like an obvious solution, cutting back on the wrong expenses can actually worsen the problem.

Through effective, ongoing cash flow management, a business can 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’s 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.