The majority of small businesses fail within the first five years of operation, and in over 80% of those cases, the cause can be traced back to problems with managing cash flow. Thankfully, with a bit of foresight and the right financial strategies, many of those cash flow issues can be mitigated or prevented altogether. Below are some of the most common cash flow pitfalls and strategies for dealing with them to ensure that your business maintains profitability and survives its crucial early years.
1. Poor Bookkeeping
For many small business owners, bookkeeping gets set aside in favor of other priorities, especially when the business is just getting off the ground, and there is a seemingly endless list of things to get in order. However, poor bookkeeping not only opens the door to potential legal issues in the event of an audit but it can also have a significant impact on your cash flow. Without a robust, up-to-date accounting system, it is easy for things to fall through the cracks, leading to unsent or unpaid invoices and no clear picture of your actual spending and earnings. Proper accounting allows you to generate useful reports so that you have a firm grasp of your cash flow and can identify any problem areas before they turn disastrous.
2. Past-Due Passivity
Unpaid client invoices are one of the biggest cash flow killers for small businesses, which is why it is crucial to have stable payment and collection policies in place and to enforce them aggressively. Some business owners choose to conduct commercial credit checks before extending payment terms, which can help you avoid taking on risky clients. Others simply lay out clear consequences for late payment, whether it’s in the form of percentage-based late penalties, work stoppage, or passing the debt off to a recovery firm. Once you’ve established internal guidelines for handling payment collection, stick to them, and be sure to send out any reminders or phone calls about due payments right away.
3. High Overhead
Overhead costs are an inescapable part of any business, but many small business owners fall into the trap of paying too much or accruing expenses that aren’t sustainable in the long term. It’s good business practice to regularly audit expenses and look for places to cut down or use cheaper alternatives. Does your business have more employees than it needs? Are you paying for excess inventory to sit on shelves because you overestimated sales volume? Is too much money going into the advertising budget? These kinds of questions can be answered by keeping a close eye on expenses and measuring them against your benchmarks.
4. Early Overspending
While most entrepreneurs can expect to operate at a loss early on, when the costs of starting a business typically exceed profits, it is all too common for new business owners to end up overspending or making impulse purchases during the startup phase. There are plenty of beneficial expenses that go into starting a business, but being able to differentiate those from the legion of unnecessary consultants, vendors, and other service providers trying to separate you from your startup capital is a crucial skill to develop if you hope to keep your cash flow out of the red. Create a detailed budget and make your best effort to stick to it, carefully weighing the cost-benefit of each expense and leaving room for any unexpected costs that are likely to crop up, and always keep your bottom line in mind when deciding on startup expenses.
5. Lack of Forecasting
Forecasting is an indispensable tool for any small business owner interested in optimizing their cash flow, and any experienced accountant should be able to create one that uses historical data and bookkeeping trends to predict periods of surplus and deficit, project future sales, and determine roughly how much money the business will need to sustain itself. In combination with categorized and benchmarked spending, cash flow forecasts can ensure that your business is on the right track for strategic growth and profitability, instead of operating on idealized or unreasonable expectations.
6. Unnecessary Business Expenses
Whether it’s out of misplaced ideas about customer service or a lack of experience, many new entrepreneurs leave money on the table when it comes to invoicing clients and customers for business expenses. If you want to keep your cash flow steady and secure, it’s important to avoid giving work away for free, so always examine your projects and business dealings to ensure that you are billing for things such as consulting, research, supplies, and mailing costs. While there may be some situations in which it’s wise to waive those expenses, such as when trying to secure a valuable long-term client in a competitive market, or when offering a promotion to attract new customers, it is generally bad for your bottom line to devote hundreds of hours a year to business-related expenses with no compensation. Just be transparent, fair, and upfront about any costs that are passed on to the customer, and use your professional discretion about what does and does not fall under those terms.
A business is only as healthy as its cash flow, and a failure to prioritize financial planning is the biggest reason that small businesses go under. By keeping a close eye out for the common issues above, and employing the strategies to correct them, entrepreneurs can ensure that their businesses experience sustainable growth and profitability.
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Universal Funding is a private funding source that has funded thousands of businesses and more than $2 billion since 1998. We turn your accounts receivable into the funding you need through invoice factoring and can have capital in your hands in a matter of days.