Dodge a Cash Flow Crisis with These Tips
When the sales are coming and the prospects for the business are looking good, it can be easy to take your eye off the cash flow. After all, it seems logical that if the management accounts show a healthy net profit, the cash will surely follow, but that isn’t always the case.
Assuming a healthy profit and loss account equates to a healthy bank account is only one cash flow management mistake you could be making. Here are nine critical cash flow management mistakes that you will want to avoid to run a profitable business.
1. Not Maintaining a Rolling Cash Flow
One of the most common reasons businesses experience cash flow issues is that they fail to manage their cash. In any company, there will be peaks and troughs of cash inflows over a month and a year. So, you need to be continually monitoring the cash position to ensure that you do not overspend in a period of low cash inflows. The best way to manage the cash is to keep a rolling cash flow forecast. The forecast, which should be updated regularly, should show weekly estimated inflows and outflows for the next four to eight weeks, and monthly figures for at least twelve months.
2. Failing to Stay on Top of Accounts Receivable
If you offer your customers credit, then you must keep on top of your collections. If you fail to get customers to pay you on time, your profit will be slow to turn into cash. Overdue sales invoices should be chased as soon as they become due. If there are any delinquent accounts, it would be advisable to take whatever action is necessary to recover the money. Always remember that, even though it is an asset, the total accounts receivable balance represents your money sitting in someone else’s bank account.
3. Being Too Generous with Customer Credit
Another receivables-related cash flow management mistake is being too generous with customer credit. It would be wise to credit-check every new customer before you offer them credit, and it would be best to keep credit limits low until customers have proven their creditworthiness. Don’t let a new customer’s promise of a large first sales order make you throw caution to the wind, either. A large order that doesn’t get paid is nothing more than a bad debt that will need to be written off.
4. Ignoring Sales Fluctuations
Many of the cash flow management mistakes that small businesses make can be put down to over-optimism. It is essential to recognize that there is no guarantee that one month of high sales will be repeated throughout the year. Even if you get a few months of continuous sales growth, it would be best to stay on the side of caution and keep your spending under control. What you may be seeing is a seasonal fluctuation, or merely a bit of good fortune. So, wait until you can assess a full year’s performance before you go on a spending spree.
5. Failing to Have a Cash Reserve
You never know what a may be lurking around the corner when you are running a business. Your business could be growing nicely, and then along comes an economic recession. Or you could lose a big customer through no fault of your own. So, it is advisable to maintain a cash reserve so that you will be covered for any unexpected events. If you do experience an exceptionally high period of sales, as mentioned above, transfer the extra cash into a reserve account. It will be safer if you can keep your windfall in an interest-bearing account until you are sure that the increase in sales is not a one-off event.
6. Focusing on Sales Rather Than Margins
Most entrepreneurs will monitor their sales figures daily. However, sales are only worth anything if you are making decent gross margins. So, it would be best if you kept an eye on your direct costs and gross margins as well. This tip may sound like stating the obvious. But it is easy to get overenthusiastic about sales and not realize that gross margins are creeping down. Accordingly, don’t make buying decisions based purely on sales; monitor the gross margins instead.
7. Spending in Anticipation of Income
If you have been in business for some time, you will be able to anticipate a certain level of regular income. However, if your business is relatively new, you cannot guarantee a steady growth in revenue. Also, it won’t be easy to forecast income in times of economic uncertainty. It would be best not to make buying decisions based on what you hope might happen. Instead, look at the most likely and worst-case scenarios before you commit to any significant purchases or taking on significant fixed costs such as leasing new office space or hiring additional staff.
8. Not Paying Creditors on Time
It is generally best to pay all your creditors on time when you can. It can be a mistake to hold back the payment of vendors merely to keep more cash in your bank account because the debts will mount up. The bank balance will look healthy, but you still owe the creditors, and the money in the bank might give you a false sense of security, leading to you overspending. Paying vendors on time will also help to build goodwill with your suppliers. So, if the time comes when you need to delay payments to suppliers, they will be more willing to grant you an extension of terms.
9. Failing to React to Downturns in Sales
Another common cash flow management mistake is not reacting quickly enough to changing conditions. If you experience a slump in sales, for example, it would be best to act quickly and start planning to reduce your cash outflow straight away. Operating in the hope that things will get better is a sure-fire way of getting yourself into a cash flow crisis.
The Bottom Line
Most cash flow management mistakes are made because business owners are overoptimistic and fail to keep a close eye on the cash. There are lots of good reasons why prudence is an accountant’s favorite word! So, manage your money prudently with the above tips, and it will help you avoid a cash flow crisis.
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.