Causes of Cash Flow Problems – 14 Mistakes for Businesses to Avoid

It’s vitally important to guard your business against some of the main causes of cash flow problems. If your company’s cash flow is poorly managed, you can quickly find debts spiralling out of control, unpaid employees leaving, and your reputation damaged with suppliers.

While there are a handful of solutions which can help to resolve cash flow problems, it’s far better to try to avoid the situation altogether. The reputational damage alone can hurt a business immeasurably. Employees and suppliers that aren’t paid on time will quickly air their concerns with others, and maybe even share their complaints online. This can potentially lead to increased difficulty in securing favourable deals with future suppliers, and deter workforce talent you may have otherwise been able to recruit.

There are a multitude of factors that can cause cash flow problems, and the following list is just a snapshot of the main offenders. Putting operational steps in place to avoid falling into one of these traps won’t just protect you from cash flow problems, but also set your business up to run as efficiently as possible. Every element listed here should be incorporated into your standard day-to-day business practice, but can be easily overlooked by busy directors. Remember, it only takes the appearance of just one of these issues to create a cash flow problem that could have a devastating effect on your business.

 

 

Waiting on outstanding invoices

This is probably the most obvious of all causes of cash flow problems.

It’s so frustrating to be waiting on money owed to you before you can pay your bills. You can see that sufficient money to cover the debts you have is due to be in your account any day now. Unfortunately, it’s not always so easy to convince creditors that you just need ‘an extra few days”. You may know that the customer or client you’re owed by is ‘good for the money’, but those you owe money to won’t always share your confidence.

While this can seem like an unavoidable part of business to some, there are some simple steps you can take to make these instances less likely. For instance, if you routinely give your customers 30 days to pay, but your suppliers generally ask you to pay within ten, then you’re inviting trouble in the future. It’s a good idea to check how frequently you need to pay suppliers and bills, and then use this to inform the time range you allow for your customers to pay you.

It’s possible to take advantage of invoice financing to get your business out of situations such as this, but solutions such as these shouldn’t be relied upon long term.

 

Low profits

If your business model is based around a low profit/high volume strategy, you may find your reserves dwindling should demand decrease. This can see businesses soon fall into the trap of waiting for next month’s takings to pay for this month’s bills.

There are many successful businesses that operate by making small profits on large numbers of sales, but each of those will be susceptible to socio-economic volatilities that can affect the number of customers they attract. For companies such as these, it may pay to diversify their offerings somewhat and introduce products or services to sell alongside their usual items that may attract fewer sales but yield a higher profit.

 

 

Insufficient emergency reserves

A float of emergency funds is essential for any size of business. This is common advice for new businesses, but owners who have experienced some sustained success can become too complacent and neglect the need for sufficient backup funds.  It’s impossible to know what waits just around the corner, and for that reason, an emergency reserve of at least three months’ worth of operating costs should always be available.

This amount may differ from business to business, and can necessitate a larger amount to cover even longer for some. The main aim here though, is to be able to cover a lean period until you’re able to navigate your business through it. Recent surveys have shown that 17% of businesses would have to fold if they suffered more than two months of declining sales.

Holding a sufficient cash reserve relieves any cash flow problems dramatically, but its important not to rely on it too heavily. If you find that you’re having to dip into your reserves regularly in order to resolve cash flow problems, you have a recurring issue on your hands that needs to be resolved.

 

Poor inventory management

Good management of your inventory can seem like a balancing act at times, and while holding too little stock can lead to plenty of problems, having too much can be even more dangerous. Even items that can be moved on quite easily can provide issues should unforeseen events take place. Take a look at this case study of one of our clients for an example of how you can quickly become overexposed to a risk you hadn’t considered beforehand.

It doesn’t necessarily take a global economic event to affect the saleability of your stock either. Imagine having a warehouse full of merchandise bearing the image of a famous footballer, then waking up to news that the same footballer has been arrested for something unsavoury. Suddenly, thousands of pounds worth of stock can become illiquid overnight.

Even without an unforeseen circumstance hampering demand for a particular item, overstocking your inventory takes cash out of easy reach for your business and into stock instead. Remember that every item you purchase with a view to sell it on for a profit is, in a sense, a gamble. Until it’s been sold, you cannot guarantee that you’ll receive your money back on your investment. It’s much safer to hold back some capital to lessen your exposure to risk.

 

High operating costs

For businesses struggling to stay afloat, a sharp rise in operating costs can be catastrophic. This could arise from a hike in suppliers’ prices, fluctuating utility bills, or an increase in rent. As all of these factors are out of your control, the only thing you can do to protect your business from them is to budget for possible rises.

If your business is only viable if your overheads stay close to what they are now, then it’s only a matter of time before it runs into trouble. Take advantage of any fixed rates you can find for utilities, and shop around for better deals. Try to forge good relationships with suppliers too. Not just your present supplier, but also those you may need to switch to if anything changes.

It’s also worth looking at your staff and premises to determine if both are suitable for your business needs. Too much staff, or too large a premises can put undue strain on a business very quickly, and soon hit your cash flow. Many of the major high-street casualties in the UK have been chains that still operated in sprawling stores that brought giant heating, lighting, and rent fees along with them. Once sales slowed, these stores were too large and overmanned, and their previously needed large size sped up their demise.

Similarly, a store that’s too small, with too little staff, can stymie sales and hit your cash flow in the form of unrealised potential revenue. Take time every so often to re-evaluate your company’s needs based on how business is going. This will make your company more resilient to changes in the market.

 

Over-investment

When things are going well, your business can seem like an unstoppable commercial juggernaut. It’s around this time though, that it’s most important for business owners to keep their heads. It can be very tempting to invest money back into the business on the latest technology, machinery, or extra staff with the assumption that each investment will bring in even more profit.

Of course, this isn’t always the case, however, and if sales slow for any reason, you can quickly find your money wrapped up in new office equipment or production tools that are of no use when it comes to paying bills. Only the largest companies will find benefit in eking out the extra 0.5% productivity that a new machine might offer. Be sure to cost up the benefits of any large purchase before taking the plunge.

 

Illiquid assets

Many small businesses overestimate the value of their assets, and will see a large asset base as an ‘emergency plan B’ if the business ever needs it.

Emergency planning such as this is flawed in several ways, not least in the fact that many expensive items can be practically illiquid when it comes to trying to move them on second hand. Delays in selling assets to raise funds leave your business at risk of accruing further late payment fees from suppliers or HMRC too.

Too many business owners make the mistake of assuming they’ll be able to recoup most of what they paid for specialist machinery. In reality, however, specialist machinery only has a very limited market that may be interested in it. What’s more, competitors in a similar sector to yourself may know that your business is struggling and thus haggle down the price safe in the knowledge that you have to sell.

 

Lacking a real budget

A 2021 survey showed that 54% of SMEs don’t have a properly documented budget. This puts over half of small businesses at risk of encountering cash flow problems in the future, if they haven’t experienced some already.

Try to update any budget year-on-year to account for rising operating fees, and ensure that you’re completely honest with yourself. Some business owners are guilty of discounting micro costs in order to make themselves feel better about their company’s projected profits. Overlooking small expenses can seem harmless, but they can soon add up and become an issue for directors looking to manage their cash flow. Use previous years’ incomings and outgoings as a guide, and then allow for a little wiggle room to accommodate any nasty surprises.

 

Seasonal demand

If your business is set up to make the majority of its profit during a certain time of year, it makes sense to try to pay your creditors around the same time. Large bills falling on your lap during your lean time of year can cause panic and seem like an insurmountable challenge to pay.

It’s best to attempt to get as many payments wrapped up during your busy period as you can. Keep a reserve of cash available to pay any unexpected costs while your business is unlikely to earn a great deal, otherwise cash flow problems can become serious very quickly.

 

Mismanaged growth

Almost every business owner wants to see their business grow, but growth itself can throw up a set of challenges that can trip up those that don’t prepare for them. You’ll need to rip up any previous budgeting plans to accommodate for the new growth, and make sure that there’s always an amount of liquidity in the business to keep its cash flow healthy.

The growth or expansion of a business generally brings with it a raft of investment costs. This can often cause cash flow problems to appear for businesses until their new structure settles into normal day-to-day operations.

It may be that any expansion or growth has to be managed in a piecemeal fashion by only adding a small element at a time. Doing everything all at once can put a heavy strain on finances that leaves owners exposed to a variety of economic headwinds.

 

Non-payment and returns

Look into your returns policy to make sure that it protects you from potential cash flow issues. If your business allows customers to return items after a lengthy period, sales that you thought had gone through long ago can suddenly disappear. If you sell expensive items, or experience a few returns at once, you can soon find that any reserves your company normally carries can be depleted significantly.

A used car showroom may have a good month by selling several cars, but if a handful of them return next month with customers asking for their money back, or even just expensive repairs under warranty, then juggling your finances can start to get tricky.

Non-payment, meanwhile, is always a risk for businesses that provide their services before asking for payment. While restaurants might be able to absorb the occasional ‘dine and dasher’, companies that spend a significant amount of time on a project can be hit hard. Tradespeople that supply expensive services such as building or decorating can spend days or even weeks on a job, only to have a customer refuse to pay.

While there may be legal routes to pursue in such instances, they’re typically not resolved quickly enough to help you keep trading if you’re struggling. For such businesses, a healthy business reserve is essential. It’s also recommended to assess your current payment policies to determine if there’s any scope for protecting yourself more. Some companies have success from breaking payments down into instalments that mean that you can effectively break even well before the final payment is due.

 

Misvalued products or services

This is such a fundamental aspect of running a business well, that it should have been sorted from inception and refined soon after opening. A surprising number of businesses though, struggle to grasp the true value of what it is they offer. Charge too much, and sales will be slow. Charge too little, and your business could be missing out on much-needed profits. Either outcome can have an impact on your cash flow.

Look at what your direct competitors are charging for similar products. Is there anything else your business can offer to sway a customer into purchasing from you apart from a cheaper price? If your offerings are priced similarly to others within your sector, incentives such as free advice or local delivery may influence buyers to choose your company instead.

Remember that a service or product is only worth what somebody is willing to pay for it too. Owners can too often become wedded to a price they think is fair, even if customers don’t seem to agree. Even if you’ve matched a similar company’s prices, you need to be careful not to compare businesses that serve very different local demographics. Those based in an affluent area can afford to charge more for the same services than a similar business based in a struggling neighbourhood.

 

Unexpected (and uninsured) expenses

As the old adage goes, ‘expect the unexpected’, and that’s especially true when it comes to running a business. A healthy cash flow is crucial for allowing the payment of unforeseen expenses. If there’s too little available, a faulty machine or broken-down vehicle can suddenly torpedo your cash reserves, and leave your business vulnerable.

If you suspect that the breakdown of a particular element of your business would be troublesome for your company, it’s worth looking into insuring against it happening. Make time to go over what any potential policy actually covers, however. Often, certain aspects will only be insured up to a certain value. You’ll need to ensure that any payout will sufficiently cover the value of the equipment you have so that you’re not left out of pocket.

Even with proper insurance in place though, you’ll still need a suitably sized reserve to last until your insurance provider pays out on your claim.

 

Overtrading

If prompt payment of your services are crucial for your cash flow, then taking on too many jobs at once can stretch your cash reserves too thinly, and leave your business at risk.

It almost seems counterproductive to turn down work if you’re hoping to run a successful business, but if you’re still waiting on unpaid invoices from other jobs, it can be risky to spend more money on the time and materials needed to start another. Have an amount of money in mind that keeps your business secure, and ask yourself if your business will dip below this if you take on an extra project. If so, it may be best to delay it if possible.

 

Is your business experiencing cash flow problems?

There are countless different reasons that your business may experience cash flow issues, not just the main culprits listed above. If your company has found itself struggling with its cash flow, it’s a good idea to get in touch with us before the situation becomes unmanageable. We’ve helped countless companies to navigate difficult financial situations with our years of experience in business recovery.

If you need to get some advice on what you can do to get your finances back on track, give one of our expert advisors a call. We offer free, no-obligation advice for any type of business. Simply call us on 0800 975 0380 or email [email protected]