Cash flow is an essential ingredient to the survival of your small business. It is the flow of money in and out of your small business, and the quantity, as well as timing of that flow, is critical to the continued operation of your business.
Cash helps your business purchase items it needs to produce products and services for profit, thereby helping your business to generate more cash for its operation. If customers are slow to pay or your pricing structure does not adequately cover the cost of production, your business will not have enough cash to continue operation. Even if your business is turning in a profit, you can still be forced to close if your business runs out of cash!
Why do small businesses encounter cash flow problems? Here are seven major reasons that result in cash flow problems for businesses, which you need to look out for as a small businesses owner:
1. Problem collecting receivables.
Money tied to receivables is just paper profit, and it is not useful to your business until you’ve actually collected and put the monies back into the business. The challenge will be collecting all those receivables, and collecting them on time.
2. Business is saddled with bad debts.
If your attempts to collect on the receivables are futile – e.g. the other parties have filed for bankruptcy or the cost of pursuing the debt is more than what you will collect – the receivables then become bad debts. Bad debts are typically written off as an expense. But the more bad debts you have, the smaller the amount of cash that you can use for your business.
3. Weak sales.
Your sales are the heart of your cash flow. The persistent lack of sales can affect how your cash coming into your business and liquidity. It is important to analyze why sales are weak and what opportunities can be done to reverse the trend. There are a number of factors that may result in weak sales, such as product lineup, labor costs, and even overcapacity.
4. Huge overhead costs.
Another common cause of the cash flow problem is when the business spends too much on overhead. Overhead costs include all costs of providing goods and services other than direct labor and direct material.
5. Weak gross margins.
Cash flow problems result if prices are too low, direct costs are too high, or a combination of both problems.
6. Seasonality of sales.
The seasonality of your sales significantly impacts the cash flow of your business. If you sell more in the winter season than other months, for example, then your sales during the winter must be big enough to carry your business through the lean times.
7. Too much cash tied in inventory for product-based businesses.
Inventory greatly impacts cash flow, especially in small organizations where cash is more difficult to get hold of than in a large corporation. In a small business, inventory problems are signals that the nuts and bolts control of a company requires attention. A good businessman knows that too much inventory is as dangerous as not enough since money tied up in inventory can severely hamper a small company’s cash flow.
For more information on avoiding cash flow mistakes for your small or home-based business, read our Cash Flow Management section
Originally published on July 8, 2009. Updated on March 13, 2020.