7 common causes of cash flow problems and how to avoid them

Key takeaways on cash flow problems in business

• Cash flow problems are often early signs of business failure and need to be taken seriously from the very beginning.
• To avoid cash flow problems, businesses should create a realistic cash flow budget, analyse past payment performance of regular customers, and review overhead costs among other techniques.
• Managing expectations and forecasting cash flow are crucial steps in preventing cash flow problems and proactively addressing them.
• Implementing a cash flow forecasting system enables businesses to take back control and even gain a competitive edge.

What do cash flow problems look like?

It’s an unfortunate fact of life that cash flow problems can be one of the earliest signs of business failure. That’s why it’s so vital to understand how to solve cash flow problems quickly, and before the situation gets out of hand. A negative cash flow can impact a business in a variety of ways.

Slow growth

If you’re not meeting your sales forecasts, it soon becomes impossible to also achieve longer term growth targets. You will also see a knock-on effect on other pipeline plans to support growth such as scaling up on staff, updating systems, or upgrading premises for example. Cash flow problems need to be dealt with quickly to avoid derailing longer term plans.

Stretching out your payment terms

Delaying paying your suppliers might feel like a short term fix but in reality, it can damage your business relationships and create a snowball effect. Not paying your suppliers on time will very quickly damage your business reputation and potentially damage your brand too.

Not being able to pay staff on time

If negative or poor cash flow becomes more sustained, it becomes increasingly difficult to access the money required to pay your staff. Payroll is often one of the largest regular outgoings for many businesses. Not paying your people on time will soon destroy worker loyalty and damage morale.

Late debt payments or defaults

Another problematic issue is maintaining regular payments for loans. This can exacerbate the cash flow problem when you add in interest charges and start racking up additional fees as a result of late payments. Eventually this will also impact your business credit rating, which in turn affects your ability to borrow in the future. It also takes a while to repair, even when cash flow has returned to positive.  

Legal action

Where negative cash flow results in unhappy creditors who are unable or unwilling to wait for the money they are owed, you may also face legal action as some will actively pursue other ways to recover their cash.

How to avoid cash flow problems

Before we dive into how to tackle poor cash flow, below are some examples of how to avoid cash flow problems arising in the first place. Take time first and check if your business is already mitigating the risk of negative cash flow with all of the following action points.

1. Don’t automatically expect to make a profit

Enthusiasm is a wonderful thing but don’t be one of those over-confident start-ups that assumes that by simply opening their new premises or launching a new website that customers will automatically arrive. When you’ve already spent cash on getting to that point, bear in mind that it might take some time to start reaping those rewards.

2. Create the right budget

Ensure you are realistic and accurate with your cash flow budget. Consider how much cash is expected to come in and when (not every customer will pay on time) and align that with what you expect to pay out over a given period. Your bills or staff shouldn’t be paid late – however some of your customers may feel that it’s fine to decide their own payment terms rather than meet yours.

3. Look at past payment performance for your regular customers

When you’re pulling together your cash flow plan, you can dig a little deeper and assess when specific customers are most likely to pay but looking at what’s gone before. Unfortunately some customers will think it’s acceptable to pay all their suppliers weeks (or even months) after a product or service has been provided – and do so as a matter of course. You can plan for this. You can also introduce ‘incentives’ to pay on time such as early payment discounts, or disincentives such as late payment fees, to try and address the issue with serial offenders.

4. Consider overhead costs and look for possible savings

It’s great to have the best equipment and the nicest work environment, but sometimes it’s necessary to rein in spending whilst you’re trying to manage cash flow tightly. Have you examined all the possible options to keep overheads to a manageable level? And are there some expenses that could be delayed or reduced?

5. Focus on accounts receivable

A sale can’t truly be counted as a sale until you’ve been paid – so do make sure that you have good procedures in place. From invoicing quickly to setting clear terms and chasing up late payers, staying on top of your accounts receivable activity is a proven way to ensure you don’t simply drift into choppy waters on the back of customers who are not paying on time. Lots of sales being agreed in principle don’t always result in good cash flow.

6. Give yourself enough of a cushion

If you run your cash flow budget too tightly, you might find problems occur when the unexpected happens such as a customer defaulting unexpectedly on their payment or even going out of business whilst still owing you money. Things do go wrong sometimes, so have a potential fall-back fund so that their issues don’t create problems for you.

7. Don’t over-order

It’s tempting to bulk order supplies, raw materials, packaging, etc., on the basis that you’ll use it anyway. But tying up money in your inventory is a common way to cause cash flow problems. Exercise caution and strategic planning when making purchasing decisions. This includes considering purchase orders in the context of bulk ordering supplies, raw materials, packaging, etc. If you don’t get through it as quickly as expected, it’s usually impossible to convert unused stock back into cash without losing money in the process. Buyer beware!

Improve cash flow with cash flow forecasting software

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