Minimize Your Company’s Risk of a Cash Flow Crunch
The most common reason cited for business failure is cash flow issues. Indeed, even a company with a healthy profit and positive net equity can fail if it lacks the liquid funds to meet its short-term liabilities. So, wouldn’t it be nice if you could run a business where cash would never be a problem? That dream scenario may not be possible, but there are steps that you can take to get close to it. Here are eight strategies that can minimize the risk of your company facing a cash flow crisis.
1. Keep a Tight Rein on Receivables
If you decide to offer credit to customers, you must stay on top of your receivables. And it is essential to remember that you do have a choice when granting customer credit. Step one to protect your cash flow against bad payers is to credit-check all new accounts. Then, back up the credit check with trade and bank references. Then, finally, if everything looks in order, only extend a new customer a limited amount of credit until they have a proven payment history with your business. It would help if you kept on top of collections, too. Chase customers for payments promptly and put credit accounts on hold if the account is not settled. If you have a persistent late payer, the safest thing to do is cancel their credit and insist on cash with order.
2. Maintain a Cash Reserve
Try to build up a reserve of cash so that you have something to fall back on in a crisis. If you have a bumper month of sales, transfer some of the windfall cash into an interest-bearing bank account. The most straightforward way to build up a cash reserve is to put aside a percentage of monthly net profits. At the end of a financial year, you can reassess your reserve level and distribute any surplus funds to equity holders or reinvest the spare cash.
3. Minimize Inventory
Whether it’s finished goods or raw materials, you can’t pay the rent with the products sitting in your storeroom or warehouse. So, aim to minimize your inventory levels so that you have more cash in the bank. You can reduce your raw materials inventory by ordering in smaller quantities and using the just-in-time purchasing model. Smaller order quantities may equate to higher costs, but it will free up more cash. To reduce your stocks of finished goods, you could consider dropping slow-moving items from your product range.
4. Minimize Fixed, Long-Term Costs
Cash flow problems are often caused by fixed, long-term commitments that cannot be met during low sales periods. Expenses like the rent for plush, downtown offices are affordable when business is booming. They soon become a significant drain on resources when downtown in sales occurs, though. To avoid getting caught in this common cash flow trap, try to avoid taking on inflexible long-term contracts. Instead, negotiate flexible deals that have short notice periods and minimal early termination payments. For example, you could opt for a short-term, renewable lease on business premises. Like purchasing in smaller quantities, short-term agreements may cost you more, but at least they won’t be the final nail in the coffin during a cash flow crisis.
5. Maintain a Short- and Long-Term Cash Flow Forecast
Your profit and loss account provides you with your historical trading results. Your balance sheet represents a snapshot of the finances of a business at a given point in time. But, to manage your cash flow, you also need a forecast of what you expect to happen in the future. It is advisable to maintain both a short-term and a long-term forecast of your cash flow position. The short-term forecast will help you manage your finances on a day to day basis. The long-term cash flow forecast will help you plan expenditure in the coming months. How frequently you will need to update your cash flow forecasts will depend on your business’s current financial state. If you have steady income and cash is not an immediate problem, updating your cash flow forecast may be a monthly task. If you are facing an imminent cash flow crisis, though, you may need to update your projections every day.
6. Flex Your Budget to Match Income
Revisit your budget at the end of each month and flex your expenditure to match your current income levels. If you have kept your costs flexible, you can then increase or decrease spending as needed. As already mentioned, cash flow crises are often merely a timing issue. So, to avoid encountering a severe cash shortage, you need to be reactive. So, keep your accounts up to date and carry out a budget review at the end of every month.
7. Switch to Cash-Only Sales
Every time you grant credit to a customer, you are taking a gamble that they will pay you, and any customers that fail to pay you on time put a strain on your cash flow. It is true that in some scenarios, you must offer credit if you want to compete. But in many sectors, you could move to cash-only sales or, at the very least, insist on a cash deposit or down payment before you ship any goods. Credit accounts are expected in many business-to-business (B2B) trading situations. But consumers are more likely to accept paying by cash. If you currently sell to both the consumer and the B2B market, you could cut your risk by swapping to a consumer cash sales only model.
8. Reduce Employee Headcount (as a last resort)
You can hire people on an at-will basis, but hiring and firing people is not always as straightforward as you may think. Firing people is not something that most people relish, so you may wind up putting off the decision. If you get a reputation for often letting people go, it could also adversely affect your brand’s image. Before you hire anyone, consider if there might be a more flexible option. For example, you might be able to outsource the work, hire a freelancer or a temporary worker for the job. Or you could hire people on short-term contracts so that there is no expectation of long-term employment. Cash flow issues are often caused by a time lag between identifying that problem and cutting costs in response. So, the best option to avoid a cash flow crisis is to make it as easy as possible to reduce costs like wages as soon as the need arises.
The Bottom Line
Business cash flow issues are generally a timing issue. If you can match your expenditure to your income, you may not always make the profit you would like, but you will not go out of business because of a cash flow crisis. Reducing your reliance on credit sales will reduce the risk of suffering bad debts. And minimizing long-term, inflexible commitments will allow you to react faster to changes in turnover.
About Universal Funding
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.