Overcome Shortages with Adequate Forecasting and Financing
When the sales graph shows an upward trend, you would expect the bank balance to be on a similar trajectory. However, expanding businesses often experience cash flow problems. A shortage of cash during a period of expansion can impede growth and, in some cases, even cause the company’s demise.
Managing the working capital of a growing business can be surprisingly challenging. However, understanding the following underlying causes of cash flow shortages in an expanding company will help you manage the situation.
1. Increased Inventory Requirements
The first impact of growth most businesses will experience is the increasing quantities of inventory required to meet demand. As sales increase, the value of purchase orders for raw materials or goods for resale also increases. However, stock needs to be purchased in advance of the sales so, as sales continue to rise, more and more cash gets tied up in inventory.
2. Impact of Stepped Costs
Costs are usually categorized as fixed or variable. Fixed expenses do not vary with output, whereas variable costs are directly linked to production or sales volume. The concept of variable costs is valid for producing a profit and loss account. Still, when translated to cash flow, it is not so straightforward. For example, you cannot buy a single unit of raw materials; you must purchase in bulk to get the best prices. Equally, you cannot add a fraction of a piece of machinery to a production line. Consequently, the cash flow outgoings increase in steps that are not always matched by a corresponding increase in sales income.
3. Investment in Infrastructure
It’s not only the direct costs that increase with sales growth. A rapidly expanding business is also likely to need to invest in infrastructure. And, like the above point, these costs will rise in steps. For example, if you needed more office space, it would be best to move to premises large enough for at least the next few years. Consequently, you would initially be paying for space you will need in the future rather than what you need now.
4. Internal System Failures
If growth isn’t planned for, internal systems will likely be stretched to breaking point. For example, you might be receiving orders, but the cumbersome order processing system could delay shipments. Alternatively, shipments might be going out the door, but sales invoices are not issued until days later. Both these scenarios, of course, will result in delays in receiving the cash due from orders received. The remedy for system failures is an investment in scalable alternatives, which requires further cash expenditure.
5. Working Capital Cycle
The working capital cycle represents the time it takes to turn net current assets into cash. There always will be a delay between buying raw materials and selling finished goods. However, if the working capital cycle is slow, that will cause significant problems for an expanding business. The process can be improved by shortening the time that inventory sits on the shelves, reducing receivable days, and increasing payable days. However, these steps take time to implement, which can be an issue when sales grow every month.
6. Cash Tied Up in Accounts Receivable
An increase in turnover can significantly impact credit control. Resources can become stretched to the point that credit checking every new customer is impossible, and chasing overdue accounts falls behind. Consequently, the risk of bad debts increases, and more cash is tied up in unpaid accounts receivable balances.
7. Unpredictability of Growth
Business growth rarely follows a smooth trajectory. Instead, increases in sales volume tend to come in spurts. Consequently, it can be challenging to predict things like inventory requirements and staffing levels with certainty. However, a business must be prepared for the peaks in demand, so the inclination will be to invest in resources to cope with the maximum turnover. That overinvestment can lead to cash shortages during the dips in sales growth.
8. Inability to Obtain Financing
The unpredictability of growth makes it difficult to know when additional funding will be required. If a company obtains financing too early, it will be saddled with high loan repayments. If financing is acquired too late, the business may experience cash flow shortages as described above. Business loan applications can also take a long time to process. So, ideally, an expanding business needs flexible financing to meet the changing funding requirements during a period of expansion.
The Bottom Line
There are many valid reasons why expansion puts a strain on cash flow. Still, these challenges can be overcome with adequate planning and financing. The crucial thing is to identify the funding requirement before embarking on an expansion program. Obtaining flexible funding, such as an overdraft facility, invoice factoring, or revolving line of credit, also will help avoid a cash flow crisis during expansion.
Your Questions Answered Quickly
Whether your business is thriving and you can’t keep up, or you are waiting on clients to pay, Universal Funding can help your growing company. Call us at 800.405.6035 or complete our rate form today to learn more about invoice factoring and how it can improve your company’s cash flow.
About Universal Funding
Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.