According to Staples, 28% of small business owners say they lose sleep over cash flow problems; 48% say they pay others before paying themselves; and 28% had experienced cash flow problems such as postponing hiring.
Cash flow doesn't have to be complicated. Indeed, most cash flow problems have common causes. The following are the 3 factors that are most often at the root of cash flow problems, as well as advice on how to avoid or overcome them.
1. Not Paying Attention to Expenses
Many businesses end up in a cash flow crunch due to unexpected expenses (for example, costly repairs to equipment, replacing malfunctioning technology or a natural disaster) or too much money going out each month (such as ongoing expenses that have quietly crept up to an unsustainable level). Resolving a cash flow crisis requires that business leadership take a renewed, vigorous look at their ongoing cost structure.
Many small business owners see the money coming in, but don’t realize just how much goes right back out the door.
Every business owner should have a rigorous process in place to track expenses on a monthly basis and project future expenses for the months ahead. A good business accountant can work with you to make sure you have an eye on the overall health of your business cash flow and are better positioned to anticipate challenges as they arise.
2. Uncertainty About Future Cash Flow
Some businesses are so caught up in the day-to-day grind of getting work done and paying bills that they don’t take time to anticipate what's coming in the next few months. Maintaining healthy cash flow requires a long-term vision. Most accounting experts recommend that every business maintain a six-month cash flow projection with expected revenue and expenses, while also adjusting for any seasonal peaks and valleys.
Small business need to make tracking cash flow a priority, and cash flow projections are a big part of that. Often when business owners first start working on a cash projection, they realize how difficult it can be to predict into the future. The good news with projections, though, is they get much easier to update over time.
3. Slow Paying Customers
Many cash flow problems are caused by a delay in receivables, such as when a company’s customers or clients are slow in paying their bills .Far too many small business owners allow their customers to become delinquent in paying them, often without fully realizing the problem until it is having a major impact on their cash flow.”
Small business owners need to put consistent policies and procedures in place to ensure that customers pay in a timely fashion. It's especially important to clarify your payment terms and expectations on every invoice, whether that’s “payment due within 30 days” or “payment due upon receipt.” Don’t assume that your customers automatically know what to expect, be clear about when you expect to be paid for your products or services.
What Options Are Available to Small Business Owners?
Small Business Invoice Financing - There are many situations where invoice financing can help. Invoice financing works best for small businesses that don’t get paid right away, but instead invoice their customers and wait to receive payment in 30, 60 or 90 days (or even later).
Sometimes, waiting for those customers to pay you can really put a crimp in your cash flow. After-all, if more money is flowing out than flowing in, you are setting yourself up for a cash crunch; which is why many small businesses wind up out of business. Theoretically, your business is doing well because you have lots of outstanding invoices, but in reality, you don’t have the cash on hand to handle immediate expenses such as payroll and inventory. This is where invoice financing comes in handy.
Invoice financing can be useful for very small businesses, and even freelancers from which an unpaid invoice can make the difference between paying that month’s mortgage or not. However, it’s also valuable for businesses with big clients that frequently are slow to pay, such as government agencies or corporations that may have a lot of red tape involved in the payment process.
Invoice financing works best as a short-term financing option that can provide the working capital you need to get over the hump until you get paid. Because you get your money quickly, invoice financing is an ideal solution when an unexpected cash crunch hits and you can’t wait for a traditional bank loan. It’s also a great solution when you don’t need a small business loan, just a little bit of extra cash.
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Small Business Cash Flow Lending
Small Business Cash flow lending companies to borrow money based on the projected future cash flows of a company. A small business cash flow lender grants a loan that is backed by the business cash flows. By definition, this means that a company borrows money from expected revenues they anticipate they will receive in the future. Credit ratings are a bit more important in this form of lending, in addition to historical cash flows.
For example, a small business that is attempting to meet its payroll obligations might use cash flow finance to pay its employees now and payback the loan, any interest on the profits and revenues generated by the employees on a future date. These loans do not require any type of physical collateral like property or assets. Instead, small business cash flow lenders examine expected future company incomes, its credit rating and its enterprise value.
The advantage to this method is that a company can obtain financing much faster, as an appraisal of collateral is not required, and underwriting time is minimal.
Institutions underwrite cash flow based loans by determining credit capacity. Typically, they will use EBITDA (a company’s earnings before interest, taxes, depreciation, and amortization) along with a credit multiplier to calculate this figure. This financing method enables lenders to account for any risk brought on by sector and economic cycles. During an economic downturn, many companies will see a decline in their EBITDA, while the risk multiplier used by the bank will also decline. The combination of these two declining numbers will reduce the available credit capacity for an organization.
Cash flow loans are better suited to small businesses that maintain high margins on their balance sheets or lack enough in hard assets to offer as collateral; these include: restaurants, breweries, coffee shops, car washes, retail stores, boutiques, wholesalers, and dry cleaners., just to name a few.
Cash flow is the lifeblood of small businesses, but sometimes due to slow receivables or unforeseen circumstances, businesses find themselves in a cash crunch. Being short of cash can be frustrating, stressful and disappointing, but with a bit of adaptability and careful planning, you can use this cash crunch as a learning experience to strengthen your business's finances for the future.