4 Tips To Solve Cash Flow Problems In Your Business

June 7, 2017

Your business is booking clients and revenues continue to grow each month. But every time you look at your bank account, there isn’t enough to any of the upcoming accounts payables. How is this possible and how can you solve it?

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How Cash Flow Problems Are Created

Let’s see how this whole scenario is created in the first place. With revenue coming in, clients happy and the business purring along, why is the bank account empty?

We’re going to look at two types of business where this commonly happens. The first is a business that has a cost of goods sold. The second is a service business.

Cash Flow Problems In COGS Based Business

A business that has a cost of goods sold produces a good that it can then sell. Basically this business holds inventory.

In order to produce the good, the business needs a supplier who it can buy raw materials from. Or a supplier that sells white label products that the business will brand as their own and sell.

Customers are places orders. The business owner gets with his supplier to have the necessary amount of raw materials to meet order demand. The cashflow crunch happens when the business takes 50 orders on credit. This means customers can pay on net 30 or net 45 day terms. Meanwhile, the business is obligated to fulfill orders.

To fulfill orders, the business must shell out money to its suppliers. Customers on the other hand get a free ride for a month before payment comes due. Let’s use a few real numbers to see how this plays out.

50 customer orders for Widget A at $100 per widget = $5000

50 orders to suppliers for Widget A raw materials at $60 per widget = $3000

Labor and other expenses for this order will be $500. Using a simplified income statement, the numbers breakdown like this:

Revenue
Product Sales: $5000

Expenses
Cost of Goods Sold: $3000
Labor: $350
Other Expenses: $150
Total Expenses: $3500

Net Income: $1500

The business stands to make a profit of $1500 if all goes well. That should funnel into the bank account.

At the time of this order, the business has $1000 in its bank account. No customer money has been received. Remember, customers don’t owe anything until 30 days from now. The suppliers want $3000 before they will send any raw materials. The business is $2000 short. With its current finances, there is no way the business can fulfill this order. BOOM!!! Cashflow crunch in progress.

Not only can’t the business not pay its suppliers, but depending on how you look at the numbers, it can’t pay its employees either.

Cash Flow Problems In Service Based Business

The difference in a service based business compared to the above COGS business is that COGS is missing. This removes the supplier, the supply chain, labor related to creating the good, and any other expenses involved in the good’s production.

Labor is still involved though with a service based business. In fact, it’s a cost driver.

Let’s use some real numbers to see how a service based business can find itself in a cash crunch.

Revenue
Service Sales: $5000

Expenses
Cost of Services: $3000
Other Expenses: $200
Total Expenses: $3200

Net Income: $1800

The business receives $5000 worth of services. However, customers are invoiced with net 30 terms.

You’ll notice we have a new term – Cost of Services. COS actually takes the place of COGS and can fit into its slot on the income statement, as shown above.

Once again, this business has $1000 in the bank. There is no way for it to cover its labor cost. The end result is that it can’t meet customer demand.

The Common Problem That Leads To Poor Cash Flow

Have you noticed the common thread that leads to cashflow issues in both cases? If you guess allowing customers to pay on credit, you are right.

But if paying on credit is common for both business’ industries, what are their options for overcoming the cash shortage?

How To Fix Cash Flow Problems

Because incoming funds are always going to lag expenses (supplier costs) in the above examples, funds from an outside source will need to be made available. This means going to investors, your own equity, or getting a loan or a few financing options.

1.) Seeking out private investors can be a good option if they are willing to pitch in and provide advice for growing your business. This assumes you do need such as advice. It will come at a high cost since the investor will want a percentage (likely high) for the funds they are investing. A stellar business plan is a must to get successful funding from an investor.

2.) Founder equity is the business owner funding the business with their own money. This is probably the best option since you don’t have to deal with investors a bank or any other entities. There is also no carrying cost unless you want to do it as a loan.

3.) Getting a loan from a bank can be difficult. Your credit score, type of business and business plan will all weigh heavy in the banks decision to issue a loan. Loans usually don’t have as high a rate as other short term options (discussed below). But assuming all goes well and you are approved, it can be an option for overcoming cash flow problems.

4.) Invoice factoring and invoice financing are probably a couple of terms you might not be familiar with. These are financing options based on your invoices. Requirements are usually that customers must be B2B or B2G and accounts receivables (invoices) must be asset based. Rates are higher than a traditional loan but qualifying is simpler.

The above options means the business will constantly be financing invoices for customers. This is part of the cost of doing business. In some cases, you may be able to take immediate payment. For example, if a customer is new or their business is new. In those scenarios, the customer’s options may be limited and started them off with no net days outstanding terms will put the financing cost back on the customer.

Want to learn more great tips about business finance? Check more related articles in our business finance section.