In business, cash is king. Managing cash flow is one of the most important lessons an entrepreneur must learn early on. More often than not, it is not revenue or profit that determines business success. Rather, it is regularly having the liquidity to be able to pay suppliers, make payroll, and fund the growth of the business.
Understanding how cash flow works and the potential issues that cash mismanagement creates is the key to maintaining stable finances. Here are some of the top cash flow problems that can hurt your business.
1. Uncontrolled growth
It may seem counterintuitive to think that a business in the growth phase could be a huge cash flow issue. After all, business growth is something that all startups and young businesses want to achieve. However, it can also hurt your business when it goes out of control.
A company experiences an increase in demand during the growth phase. To meet this demand, the company will need to expand parts of its operations. This includes hiring more staff to manage the supply side and the demand side of the business, renting larger office space to house additional staff, and purchasing more inventory.
These expenses are necessary but they take quite a chunk of cash reserves. Cash flow shortage is the norm if your business is in an industry with long billing cycles, as you need to pay for growth expenses even before your invoices are paid. The faster and bigger your growth is, the faster and bigger the impact on your cash flow.
Growth is almost always the goal of businesses, but it is vital that you are aware of the potential cash flow issues that come with it when it comes faster than expected. Analyze how stabilize your growth is before you commit to another increase in the expansion of your operations.
2. Bad debts
Bad debts are amounts owed by customers that are no longer collectible. There is always a risk of nonpayment every time you extend credit to customers. However, that does not mean there is nothing you can do to minimize unpaid invoices. If there is no system in place to manage invoices, then your cash flow may be crippled by bad debts.
There are several approaches you can do to minimize the likelihood of bad debts. First, you should always vet a potential client’s credit rating before taking them as customers and extending them credit. If you take clients that are known for paying late, your company may not be able to collect payment for your hard work. You can check public records if there are outstanding liens on property they own or manage. However, if you still want to take a client with less than stellar credit records, you can ask for a higher upfront deposit and then issue partial invoices. Also, always make sure that you file appropriate lien notices to protect your right to due payment.
Record-keeping and documentation are also critical to managing your invoices. Ensuring the accuracy of all necessary payment information will prevent payment delays. This also allows you to see which accounts are overdue or in danger of being bad debts. If you are doing business in construction, then you also need to send a preliminary notice. This legal document informs the client of their obligation to pay you and is key to protecting your right to file a lien on the property.
Set aside some time to send reminders to clients about overdue invoices. The faster you talk to your customers, the more likely it is you can collect payment for your products and services.
3. Haphazard spending
“It takes money to make money” is an oft-repeated adage in business, and to some extent, it is true. However, spending impulsively on things your business will not benefit from will create a cash flow shortage. Not all expenses and investments are equal so you need to think twice and consider the cost versus benefit of every single expense. Every dollar counts as, ultimately, the money you spend is taken away from your profit margin.
The best way to combat impulse spending is to create a cash-flow-based budget and stick to it. Analyzing your cash flow statement will help you track the inflow of revenue and outflow of expenses in a specified time period. This allows you to forecast and create a realistic budget, including leeway for some unexpected expenses. Any extra spending can wait when you can actually afford it.
Dealing with cash flow issues, especially early on in your business, is daunting for any entrepreneur. But as long as you take an objective look at your finances, curb your spending, and manage your invoices, you will be set for success in the long term.
About the Author
Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers with late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.