There is a very valid reason why cashflow is referred to as the blood of a business. This is because no matter how great the business idea or the amount of capital invested in the business or how potentially profitable the business may be, if cash flow isn’t properly managed, it is only a matter of time before the business folds-up.
Every business needs a healthy cash flow. The business needs to be invoicing regularly and making sure clients pay their bills on time so that the business can do likewise.
There are numerous reasons why a business should ensure cash flow is properly and effectively managed. Without such good systems in place, the business risks encountering a number of awkward financial problems such as
- Insufficient money to pay staff salaries
- Insufficient money to pay the business owner’s salary
- The business can’t afford to buy supplies
- The business gets a reputation as a poor payer
- Debtors avoid paying on time or at all
- Debtors go out of business before making payment.
These awkward circumstances are definitely bad for business. The good news is that they can be avoided, prevented or minimized to save the business from going under. Here are the most common cashflow mistakes and what you should be doing about them.
Over-Estimating Future Sales Volume
Most entrepreneurs are optimists by nature. Optimism is definitely very critical for every business owner but it should be checked so that it doesn’t compromise the objectivity of the cashflow and expense planning.
Whatever the value proposition of any business, not every interested prospective customer will actually make a purchase. Making actual expenditures based on yet to be concluded sales or account receivables is a risk that must be mitigated.
While sales volume increases during some particular time of the year, expecting them to double is a little unrealistic. That is why it is so important to complete objective and realistic sales forecasts established on historical happenings and real numbers periodically. By applying such forecasting methods, actual past revenue data from the business or another business in the same industry can be used as a basis for keeping abreast with trends and predicting future sales. This useful information along with some objective entrepreneur intuition will help in a more realistic future sales projection.
For a startup business, revenue forecasting can be especially difficult since the business doesn’t have past sales figures or experience to provide such planning information. It is advisable for such businesses to seek advice from someone with experience in a similar business to help project future sales.
Irrespective of the method used, it is to be made clear that the future sales expectation should be based on objective facts and sound judgment.
No Policy for Credit Sales and for recovering Over-Due Payments
If your business is going to offer credit sales to customers, it is important to have clearly stated credit policies signed to by the customer. Such policies must cover due date, payment plan and penalty for late payment and default.
One of the most common and deadliest cash-flow killers for small businesses results from unpaid invoices from clients. If you aren’t proactive about collecting payments from your clients, you could be on your way to a dangerous cash-flow situation. Sadly, small businesses that don’t have solid late-payment penalties and collection policies in place are often taken advantage of. If your clients don’t know for sure that they will hear from you the moment a payment is late, you are sure to be the last of their vendors to get paid.
Our general advice to clients who want to offer credit sales to their customers is that they should offer credit sales only to customers they have transacted with for more than a year and whose transaction value exceed a certain benchmark.
Extravagant Spending during Startup Phase
Many entrepreneurs invest too early and too much in renting big offices at prime locations, expensive office furniture, shiny suits and official cars even before proving their business models and acquiring a sizeable number of customers to sustain the business. Their common justifications for these actions are statements such as “you have to look the part to be successful” and “it takes money to make money”. While this can be true to an extent, rookie entrepreneurs do fall prey to gross overspending especially in the first few months of business.
In reality, it does take money to make money but at the early stage of the business, the business should prioritize beneficial expenses – expenses that will benefit the business’ profitability in many ways and focus resources on customer acquisition. It is only after the business has sufficiently proven its business model and achieve product-market fit does it become beneficial to invest in the good-to-haves of business.
Cost-benefit analysis at every point in the business will also help mitigate against extravagant spending.
Not Keeping Backup Cash on Hand
One can never know what could happen, a business with a zero-account balance and one month of slow sales could mean instant disaster. No matter the financial security put in place to protect a business’ cash, epileptic cash flow is a business reality. This can be solved by having cushion of savings at hand.
Make sure there is an account balance of at least two months of operating expenses so that if sudden cash flow obstacles spring up, there will be reserve in place to support the business until it is back on track.
Cashflow issues are one of the biggest challenges facing businesses. But when a business stays objective, checks unnecessary spending and stays alert to potential pitfalls then that business will be ahead of its peers for long-term business success.
Not Using a Cashflow Statement
Setting realistic targets for future sales, checking spending and doing everything to make sure clients pay up can do wonders for a business’ long-term cash flow. But the business can find itself in a tight spot if the cash flow is not tracked day-to-day.
Using a cash flow statement will help track the inflow of revenue and outflow of expenses during a specific time period. This will help in anticipating the movement of money in and out of the business and help with planning future cash needs.
Managing the cashflow of a business is mission critical for any business that desires more than survival.