Why Understanding Your Business is Key to Preventing a Cash Flow Crunch¹

Why Understanding Your Business is Key to Preventing a Cash Flow Crunch

Business owners and managers need reliable, real-time information of current and future cash flow levels to manage the cash demands of their business. Here's how a robust cash flow management system can prevent a potentially crippling cash crunch:

When it comes to running successful business cash is often king; and business owners who understand this apply extra care in managing their cash flow on an ongoing basis. For a small business or a business still in startup mode every dollar counts; and even small errors in sales and revenue collection can put the entire business at risk. Cash flow becomes particularly problematic when a sale is completed but the invoice isn’t paid in a timely fashion, putting the seller in a precarious cash position.

Sometimes businesses most pressing cash flow issues come about when sales increase beyond a level easily supported by available cash. When growth becomes constrained by the amount of cash on hand, or when growth actually drains cash down to dangerous levels unsuspecting business owners end up with books filled with receivables but not enough cash on hand to pay expenses. In other instances, it’s an unexpected downturn in the economy that puts cash-strapped small businesses at risk by causing customers to delay payments at the same time as suppliers become more restrictive in offering payment terms.

Without a robust system in place for managing cash flow, even a strong, fast-growing business may be at risk of a significant cash crunch. Putting a proven and efficient system in place for managing cash flow that provides real-time information on current and future cash flow levels is essential to prevent a cash flow crunch.

Analyzing the amount and timing of cash flows is critical

For small business managers and owners it’s an imperative to know, with the greatest certainty possible, the cash demands being placed on the business. Matching up the timing of cash inflows and outflows to the ongoing requirements of the business is a critical task, but too many businesses struggle to accomplish this with physical ledgers or electronic spreadsheets. An accurate, real-time understanding of the business cash flows can enhance strategic decision making and prevent a cash flow disaster, but, without the right technology and systems, it’s hard to succeed at cash flow management. While reliable cash flow management systems used to be limited to large corporations with deep pockets, today things have changed, and technology improvements have brought these tools to within easy reach of most small businesses.

Where is the cash going to come from?

There comes a point for every business when unplanned events conspire to disrupt cash flow. It may be an expense that comes in higher than expected, or a large purchase needed to complete a project, or replacing aging equipment that is holding back growth. Whatever the reason, these unexpected costs can put a crimp in cash flow for months at a time and it can be difficult, if not impossible, to source a loan to bridge the cash gap.

Establishing a system that accurately forecasts future demands on cash and matches those needs to planned cash inflows can help a business owner navigate these difficulties. Savvy business owners who see an upcoming demand for cash can proactively take action, sometimes by factoring their accounts receivable. This form of financing allows a business to sell invoices to an intermediary and get paid today, usually in exchange for a discount on the face value of the invoices being sold. For many businesses this trade-off of getting paid slightly less than full value but getting paid without delay is well worth what usually amounts to discount of between 3-10%.

Of course the ability to maximize the benefits of creative strategies, like accounts receivable factoring, requires a strong cash flow management system. Selling invoices and the headaches of collecting on them or engaging in other short-term forms of financing is most effective when matched to a systematic method for tracking cash inflows and outflows against each other.

Factoring is not the only way to generate short term cash. For some businesses, it makes sense to clear existing inventory at lower prices. Others are better served by selling equipment and entering into a lease with the purchaser, freeing up working capital otherwise tied up in the physical equipment. An alternative to this strategy is simply selling surplus assets to raise cash for the business.

Prevent a cash flow disaster with these simple steps

  1. Understand timing. For businesses that have predictable patterns, whether it’s sales fluctuations, seasonality, or inventory cycles, the lesson is the same. Prepare for when cash is needed by establishing a source of funding before emergency strikes.
  2. Prepare for any borrowing. When it comes to taking out loans it’s important to take a practical view of your business circumstances. What level of borrowing is appropriate given the performance of the business, and do the key assumptions for why you are taking out a loan and how you are paying it back based on reality or imagination? A mistake here can be catastrophic for even the soundest companies.
  3. Inventory can drain cash. Building up inventory drains cash from the business, and the sale of inventory only brings in cash when the buyer actually pays. For his reason it’s important to have a firm grasp on the age of any inventory and the receivables associated with it, as misalignment here can cause an unexpected cash shortfall.
  4. Keep your friends close. It’s particularly important to keep a close eye on vendors. Those who suddenly demand payment before due may be in trouble, much like a client who is stalling on paying your invoices. To preserve healthy long term business relationships with your suppliers and customers it’s important to keep communicating in good times and in bad so that you can quickly negotiate and adjust to changes in circumstance.
  5. And keep your expenses closer. Sometimes the easy answer during a cash crisis isn’t a good idea. Throttling back expenses that are critical to delivering your product or collecting payment from clients is a surefire way to exacerbate a cash crunch.

Even the strongest cash flow management system will be vulnerable to the unexpected. When the economy takes a turn for the worse or the competitive environment in your industry suddenly shifts your cash flow can be impacted on short notice. At times like this a solid understanding of your business, combined with a disciplined approach to cash flow management, can help weather the storm and give your business time to get back on track.