The 5 main causes of cash flow problems, cash flow business.#Cash #flow #business
The 5 main causes of cash flow problems
Anywhere in the world, whether you are in Australia, UK, US, Canada, or elsewhere, the causes of cash flow problems are the same!
CASH IS KING
- The ability to generate positive cash flow year in year out is essential for a business to be viable in the long term.
- Surplus cash flow lubricates growth of a business.
- It is impossible to successfully grow a business unless it is both profitable AND generates surplus cash flow on a sustainable basis.
- Without strong, positive cash flow a business will never thrive and grow.
- Inadequate cash flow is a symptom of management problems in a business, NOT the cause.
Evidence of Cash Flow Problems
- Late payment or non payment of supplier invoices, direct debits being dishonoured, late payment of taxes and employee superannuation, even worse being late payment of wages to staff.
- More extreme evidence of cash flow problems is legal action against your company by suppliers or the tax office.
- If these problems sound familiar to you and your business, it is time for you to take immediate action to address your cash flow problems.
- You are stressed and it is affecting your family as well.
In this article, we take a look at the 5 main causes of cash flow problems in a business.
Knowing these dangers will help you develop effective cash flow management and maintain a healthy business cash flow.
Cause 1 – Declining Sales and/or Declining Gross Profit Margins
a) Declining Sales
- Declining sales have a devastating effect on your cash flow as a relatively small decline can cause a massive reduction in your profitability.
- This typically occurs when economic conditions deteriorate, there is an increase in competition from global competitors, new competitors enter your market, or your industry declines.
- As sales decline your overheads will probably remain unchanged so net profit decreases rapidly.
- A detailed table in the addendum at the end of this article vividly demonstrates the devastating effect of declining sales.
b) Declining Gross Profit Margins
- Declining gross profit margins have a devastating effect on your cash flow as a relatively small decline can cause a massive reduction in your profitability.
- Typically occurs when there is pressure on sales.
- A detailed table in the addendum at the end of this article vividly demonstrates the devastating effect of declining gross profit margins.
Cause 2 – Your Business Is Unprofitable
- Simply put, you are spending more than you are charging to provide your customers with goods or services. For example for every $1,000 or 1,000 you charge your customer you are spending $1,050 or 1,050! That is for every $1,000,000 or 1,000,000 you earn you are spending $1,050,000 or 1,050,000!
- Inevitably your losses will accumulate to the point of having to borrow more money just to stay in business. But eventually you will come to the point where it is neither wise nor possible to borrow more money and you will have to sell your business, close it down, liquidate it, or someone else will liquidate it for you, for example the tax office.
- A much better solution is to take immediate action to restructure your business to generate strong and sustainable profits, this will probably require a very experienced business turnaround specialist to guide you through this process.
Main causes of lack of profitability include:
- A flawed business model.
- An underperforming business, either your sales marketing and/or operations are not working like clockwork.
- Lack of understanding of financial statements.
- Lack of accurate and timely financial statements.
- Lack of KPI s (Key Performance Indicators) and strict monitoring of them
- Low gross profit margins due to high direct costs and/or not charging enough for your products/services and/or extreme competitive industry pressures.
- Poor performance and lack of productivity of staff.
- Poor processes, many errors/defects.
- Poor stock purchasing and management.
- Excessive overheads.
- Excessive interest and/or vehicle and equipment finance commitments.
- Poor credit approval of customers and poor debtor collection management practices resulting in high bad debts experience.
- Undisciplined spending.
Cause 3 – You Have a Natural Negative Cash Flow Business Model
- You sell on credit terms, 30, 60, or even 90 day terms, but you have to pay your payroll, rent, overheads weeks if not months before you are paid by your customers. And your payment terms with your suppliers are shorter than the payment terms you have given your customers.
- You carry imported stock which you have paid for weeks or months before it lands in your warehouse.
- You are paid by way of progress claims for which you also provide credit so you receive payment long after you have paid your direct factory expenses or subcontractors and materials expenses. Furthermore, retention payments are withheld by your head contractors or by your customer.
There are ways to address every one of these circumstances which involve redesigning your business model and also using appropriate means of financing, most of which are still available, even if you are already in financial distress.
Cause 4 – Excessive Debt and Capital Expenditure and/or Excessive Personal Drawings/Benefits
- High repayments due to excessive debt and/or repayment of loans over too short a period. This especially applies to vehicle and equipment loans and lease repayments which are typically structured over relatively short terms with low or nil balloon or residual values.
- Capital expenditure funded out of cash flow instead of being financed over the useful life of the asset which puts pressure on cash flow.
- Funding purchase of personal property assets or the repayments on these properties far beyond the capacity of your business to sustain these payments as well as meeting the ongoing payment of all business expenses within normal trading terms including taxes and superannuation.
- Excessive living and lifestyle expenses.
Cause 5 – Poor Stock or Poor Credit and Debtor Management
- Poor stock management, such as carrying stock that doesn t sell through, carrying excessive levels of stock, not clearing discontinued or obsolete stock, poor demand planning, undisciplined purchasing habits, or a poor stock management system to name a few.
- Poor credit management, that is no or poor credit approval processes before providing customers with credit which will sooner or later result in bad debt write offs and in the worst cases will result in failure of the business.
- Poor debtor management which includes lack of disciplined collection of debts due by customers, allowing continued credit when customers have not paid their bills within company credit terms, and lack of regular reconciling of debtors accounts.
Some Final Words
- Disciplined cash flow forecasting and management is critical to your business.
- If you are experiencing some of the above issues in your business you need to address them urgently. Unless you can address these problems immediately you may be wise to engage the services of a very experienced business turnaround specialist to help you effectively plan and manage your cash flow and deal with the root causes of your cash flow problems.
a) Detailed Analysis of Impact of Declining Sales
- In the table below, sales are progressively reduced dramatically reducing net profit margin.
- Note that all figures are presented as cents in the dollar/pence in the pound. Therefore, by way of explanation for normal sales column:
Sales = 100 cents/pence
Cost of Sales = 65 cents/pence
Gross Profit = 35 cents/pence