A recent study has found that more than 80% of all startups and small businesses fail due to poor cash flow management. That means that, however brilliant your idea or business model, however profitable on paper your enterprise, however good the quality of people with whom you work, if you cannot manage your cash flow, you will not survive.
There are a number of common mistakes businesses make when it comes to managing their cash flow.
- They are too optimistic. Whilst a positive outlook and never-say-never attitude is important for any business owner and entrepreneur, over optimism can be a major weakness when it comes to estimating the strength of your business, especially when it comes to sales. Forecast sales based on real, historic data where available, rather than using wild assumptions and hopes. Where there is no historic data available, such as in the first months or year of business, apply a heavy dose of pessimism when forecasting initial sales or revenue. The worst that can happen is that you completely underestimate your sales or revenue. Much better, and safer, than the opposite.
- Over spend during the start-up phase. While the expression “you have to speculate to accumulate” can be a truism in business, there is a tendency to over spend when you are just starting out, and to put your cash flow under pressure from the outset.
Fancy offices and premises, expensive computers and servers, top of the range accessories, equipment and advisers are all affordable for a successful, established business. For a start-up, however, they can be a costly luxury which could be avoided. Work from home, or rent office space in the cheaper suburbs rather than a town or city centre. Minimise expenditure on IT and buy only what you really need, using sales and promotional offers to get as big a bargain as possible. Outsource website design and IT and server maintenance to third party providers. Avoid “big name” lawyers, accountants and auditors. Local consultants offer much better value and often are of an equal, or even superior, quality and skill,
Above all, do not hire staff until the business economics fully support it. Personnel costs are usually the largest expense in any business and the hardest to reduce when times get tough. When you hire people you not only have to pay their salaries and related costs such as tax, social security payments, health insurance and pension provisions, you are also expected to make a commitment to them in terms of time, career development and training. Better, in the early stages at least, to use consultants who will bring existing expertise and knowledge, with no training need on your part, and where a contracted relationship can be concluded easily, without the sometimes protracted legal consequences associated with terminating an employee.
Avoid unnecessary initial expenses, minimise waste and outsource all but the essential tasks in the early months.
- Fail to proactively manage receivables. One of the biggest reasons many businesses find themselves in cash flow difficulties is the late payment of invoices by customers. This is a problem which besets businesses of all sized and in nearly every industry and sector. The impact, however, for small businesses can be fatal, directly affecting its ability, in turn, to pay salaries, suppliers and other stakeholders, sometimes forcing them into bankruptcy.
A small business needs to have clear payment terms for sales invoices, with penalties for late payment and/or the threat of work cessation for ongoing projects. Giving discounts for early payment could also be considered.
However you tackle it, the most important factor is to take a proactive approach to receivables. Many small businesses are so grateful to have a customer’s business that they are nervous of offending them by asking payment of what is due to them! This gives all the power to the client, and, in many cases, they will take advantage of this, either consciously or not. The result is that their cash flow benefits at the expense of yours.
Much better to establish a proper, commercial relationship with your client from the outset. Set out your invoice terms and policies, and respectfully, but firmly, make sure that you stick to them.
- Have no “rainy-day” cushion. No matter how carefully you manage the business, setbacks occur which can affect cash flow. A sudden drop in sales, an unexpected cost, a natural disaster like bad weather or a flood, a public relations or marketing issue. All of these events can put your business model under sudden pressure. If you have a cushion of savings on hand, these unexpected occurrences can be survived, at least in the short-term. However, if you are living a hand-to-mouth existence, a sudden downturn or expense could signal disaster.
The best way to cushion yourself from these “rainy day” events is to have a least 2 months’ operating expenses in reserve. This will allow you to ride out any unforeseen storms without an immediate impact on your business. It will also give you time to try and find some additional funding if the problem causing the cash flow pressure looks likely to continue beyond the short-term.
- Fail to use a cash flow budget or forecast. Setting realistic sales targets, maintaining a tight control on expenses, proactively managing accounts receivables, and having a rainy-day cushion all help a company’s long-term cash flow. But, unless you track and monitor this on a day-to-day basis, your business could still founder.
Using a cash flow statement and forecast will not only help track revenue and expenses over a specific time period, but it will also enable you to identify “pinch points” and likely problem periods. For example, if supplier payments will become due for inventory before the resultant sales of that stock, then there could be a problem paying bills on time.
Proper cash flow forecasting and tracking helps you plan ahead and make contingency arrangements, rather than simply reacting to events as they happen. Without such tools in place, you are just guessing and hoping you are going to have enough cash in hand to meet the bills that become due. Not an enviable position to be in for any business owner.
If you feel you lack the skills, knowledge, or experience to monitor and forecast your cash flow properly, consider hiring expertise such as AJD Consultants. They provide highly qualified, expert advice and knowledge to small businesses and entrepreneurs. They will provide the tools to monitor your cash flow projections and needs, as well as offering advice to to how to improve your business performance, profitability and processes.
Cash flow management is one of the greatest challenges of business ownership. The statistics prove the likelihood and the high cost of getting it wrong. But, if you can be realistic in forecasting sales, maintain a tight rein on costs, actively manage your receivables, keep a suitable “rainy day” cushion and, above all, monitor closely and forecast your cash needs, you will be well set for long-term business survival and success.