Often you will hear that cash flow is the major reason many small business close their doors. This is true, because all other reasons of business failure must result to cash flow issue before a firm goes bankrupt. Cash is the life blood of any form of business as no business can survive long without a good cash flow. Therefore, it is important for managers to understand some of the common causes of small business cash flow issues.
1. Buying too much of Stock
Small businesses sometimes buy a 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 inflows, the business will be put under cash pressure. Such pressure from vendors and other suppliers can even force the firm the sell the goods at loss. Goods can sometimes be cheaper in the market but buying too much of stock can also tie cash liquidity.
2. 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 process to assess the impacts of such decision on the business cash flows.
3. 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. Therefore, it is important to prepare a periodic list of short term assets and liabilities for you to track the working capital position.
4. 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 60% of your receivable to be outstanding with only one customer.
5. Diverting business funds
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.
If the funds of the business are spent on personal transactions then cash flow issues can visit your office at anytime.
6. Collection and Payment Period Mismatch
If your business sales goods or offer services on credit, you need to ensure an 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.
Small businesses growth are hugely dependent on cash flow, therefore managers must either cut costs or scramble to find alternative funding when they are not being paid on time. You should also have enough cash reserves to cover your slow months in business.