Recognizing Cash Flow Problems & How to Solve Them
We know that the majority of small businesses fail within the first five years, but a study by Jessie Hagen, previously with U.S. Bank, drilled down into the reasons why this occurs. In her study, she found that 82% of the time, poor cash flow management or poor understanding of cash flow contributed to the failure of a small business.
Why Small Businesses Fail
According to research done by Jessie Hagen, formerly with U.S. Bank, and cited on the SCORE, the reason small businesses fail overwhelmingly includes cash flow issues. This includes poor cash flow management and poor understanding of cash flow, starting out with too little money, and lack of a developed business plan.
- 82% – Poor cash flow management skills/poor understanding of cash flow
- 79% – Starting out with too little money
- 78% – Lack of well-developed business plan, including insufficient research on the business before starting it
- 77% – Not pricing properly or failure to include all necessary items when setting prices
- 73% – Being overly optimistic about achievable sales, money required, and about what needs to be done to be successful
- 70% – Not recognizing or ignoring what they don’t do well and not seeking help from those who do
How do you know if you have a cash flow problem?
While there are multiple factors to consider with cash flow depending on industry and the lifecycle stage of your company, one key is relevant to all small businesses regardless of size or industry: If your expenses exceed your cash, then you have a cash flow problem.
It’s important to note that your expenses, especially during the early stages of growth, are most likely going to be greater than your revenue—you’re still trying to validate R&D, go to market, figure out sales and marketing, admin costs, and contractor relationships, etc. It’s also important to remember that your company will only be successful if you can eventually bring in more than you spend.
However, regardless of your lifecycle stage, industry, or plans for growth, your expenses should never exceed your existing cash.
If our small business has a cash flow problem does that mean we need to focus on selling more?
Not necessarily.
In an article authored by entrepreneur Tim Berry on Entrepreneur.com, he shares: “One of the toughest years my company had was when we doubled sales and almost went broke. We were building things two months in advance and getting the money from sales six months late. Add growth to that and it can be like a Trojan horse, hiding a problem inside a solution. Yes, of course you want to grow; we all want to grow our businesses. But be careful because growth costs cash. It’s a matter of working capital. The faster you grow, the more financing you need.”
Instead of “Sell, sell, sell,” how should we address cash flow problems?
There are several factors to consider before leaping to the “sell, sell, sell!” mindset to reverse a cash flow problem.
1. Categorize your spending. Your first step should be to know exactly what you’re spending and where you’re spending it. Categorize your expenses into G&A, R&D, Sales & Marketing, Operations, and COGS, and see if anything stands out. Note the percentage spends for each category, and analyze whether the cash distribution makes sense.
2. Benchmark.You should have a clear picture of how other businesses are spending and use those benchmarks to spend similarly. Consider businesses within your industry as well as businesses within your company’s lifecycle stage. Remember, you don’t want to spend more cash than you have, so regardless of benchmarks derived from other companies, adjust accordingly depending on your available cash.
3. Micromanage Your Spending. You’ve probably heard the saying “It takes money to make money,” but this common belief can cause new entrepreneurs to fall prey to gross overspending, especially during their first few months of business. While it does take money to make money, not all expenses are created equal. Remember that every dollar you spend is detracting from your profit margin, so especially during the early stages, it is important to consider the cost-benefit of every single expense.
Most importantly of all: Forecast
We’ve talked about the importance of forecasting before, and when it comes to cash flow, forecasts are no less important. Small businesses want to grow, and want to grow as quickly as possible, and a detailed forecast can make sure you can accomplish that growth in a sustainable and efficient way.
From implementing your benchmarking from point number 2 above, to knowing when to bring in extra cash from debt or equity financing, a forecast helps to take out the guesswork and put your business on a path of strategic advancement.
The Importance of Short- and Long-Term Forecasting
Cash flow is about planning, analyzing, and awareness
Creating a detailed forecast and using that information to drive a budget for your company is one of the most impactful steps your company can take toward intelligent cash flow management. Combining a thoughtful forecast with heightened awareness of your spending as well as the cost-benefit analysis of each expense means you will have the information and planning in place that can help you achieve more sustainable growth.
How can we help?
Are you unsure whether you have a cash flow problem, or do you want to discuss strategies for creating more sustainable growth? Schedule a free financial consultation with one of our experienced CFOs today or ask a question by clicking the button below.
This article was originally published in June 2020 and was updated in November 2023 for the most recent resources, information, and relevance.
