Solving Cash Flow Problems in a Small Business

Would businesses fail if they had an accurate cash flow forecast and they knew how to identify cash flow problems?

Knowing the nature and extent of your cash flow problems is key to being able to solve the issues that are causing it, solving short term problems, and avoiding the next one. Most businesses have some idea about cash flow but fail in the details.

An example of cash management failure

We once worked with a company whose previous bookkeeper could not deliver proper job costing reports. When Entreflow took over the file, we dug into the numbers and found issues with their labour jobs. It turns out that they never estimated labour anywhere close to reality and even though they had a contingency in place to go back to the customer for more budget if the job took longer than expected, they never exercised this. They were essentially paying for the labour for their clients — what kind people! Because of this, cash was always tight. They needed a new pricing strategy, but they also needed a cashflow forecast to ensure that they could finish off the year solidly.

Forbes lists cash as the 2nd most commonly reported reason for start-up business failure even amongst funded ventures.

Why you should plan your cash flow

For businesses that have high upfront costs before they can earn revenue, cash flow planning is a must. It can be done for any period of time. However, for most startups and growing companies, it’s most useful to use monthly predictions. If it’s built correctly, there will be no significant surprises, you’ll know reliably how much runway you have, and you’ll have a model you can use to conduct what-if analysis on business decisions.

The first step to cash flow planning is that you’ll need to collect some data. You’ll need to know when all of your bills need to be paid, what pre-authorized debits you have, so you know when money is going out of your account. Payroll is often the largest cash expense so make sure to forecast it properly — many businesses forget to include 3-payroll months, bonuses, benefits, hiring expenses, vacation pay, payroll tax. Also make sure to look for annual or quarterly bills. If you have a cloud-based accounting software like Quickbooks Online or Xero, you should be able to get these data quite easily.

Next, you’ll also need to separate out what are fixed costs, and what are variable costs. Fixed expenses are committed; variable costs go up as sales volume and related activity increases. A Fractional CFO can help with your cash forecasting and cash management.

I say start with sales. The old adage goes “Sales fixes everything”. It’s not quite true, but for a start-up or growth company, you want to show investors that top-line revenue increasing every month, and more sales mean more cash for you.

Our CFO team has worked with an on-demand services start-up company that used this strategy. They eventually corrected their cash flow problems. Easy to say, right? Just sell more. If it was easy as that you’d have done it, but there are specific strategies that make sense for selling in a cash crunch:

• Tactic A: Join the sales team. If you’re a business leader and you’re not contributing to sales right now, get involved. You have the passion and the fire. Get dirty.
• Tactic B: The easiest place to get quick sales is with existing customers. They’ve already bought from you. Contact them all and find out if they need more of what they’ve got, and find out if they need any related products and services.
• Tactic C: Create a new offering. My client had been selling the kind of service package that their customers would use 10–20 times per year, ad-hoc. In a short-term cash crunch, they were able to pre-sell bundles, get the cash in immediately, and deliver later. Creating a different package for the same product.
• Tactic D: Hire a rain-maker. Depending on your cash horizon, you could have time to bring someone on with a lot of connections to bring in a lot of sales quickly.

Let’s say your revenue is taking off but you still need some more runway. To build the runway you’re going to have to cut costs. But you have to be smart about it so you don’t kill your future.

We worked for a start-up that had raised millions and had 30 staff. They were going hard on sales but it wasn’t taking off fast enough. We saw that they were down to a 1-month runway and there was this pivotal meeting one day where we had to lay out “You’re going to run out of money unless we do something drastic”. The executive team did what they needed to do very quickly. Within a few days, we bought another 8 months of runway, so it’s possible. Here are a few tips that companies often miss:

• Tactic A: Reduce cost of goods sold If you are running the kind of business where your margin on each sale is lower than 40–50%, then moving this needle could have the biggest impact on your business. Examine your purchasing/sourcing practices, set metrics on the efficiency here.
• Tactic B: Cut marketing. Take a look at your cost of client acquisition. For many young, growing companies, marketing spend is poorly allocated since you don’t have a long history to tell you what works, so you’re throwing money away. Get expert help on this from an outside marketing consultant — and I mean one who’s managed a budget before. You’ll need to measure what’s working, run experiments, and allocate budget properly.
• Tactic C: Cut software expenses.  I found $23,000 once for a company that was (A) paying for enterprise software that was completely overkill for what it needed and (B) paying for a bunch of CRM users it didn’t need after downsizing its team.
• Tactic D: cut payroll, but very carefully  — layoffs should be a last resort for growing companies. Do get rid of dead-weight, but keep good people if you can. It is very costly to grow a team and you’re going to have to hire new people at some point. Layoffs are also culture killers. Consider some alternatives: if it is legal in your area, ask employees if they’d be willing to take a temporary pay cut, to work reduced hours, or to trade cash for equity.

One company we worked with had a huge Accounts Receivable problem. 70% of their revenue came from one customer and that customer started asking for longer payment terms Because of this, the accounts receivable grew from $500k to $2m. In the end, they had to go into negotiations and were able to recover their accounts receivable balance. The point is there’s a downside to payment terms and also an upside.

• Tactic A: Set reasonable payment terms. You are not a bank for your customers. You want to make sure to set reasonable payment terms. After a couple of months working with customers — once you have built a rapport with them — you should go back to customers who have longer payment terms and negotiate. The other important thing is to be firm on collections and charge penalties for late payments.
• Tactic B: Negotiate with suppliers and software providers. Just like you would do with your customers, you should be going back after a couple of months of working with your suppliers and negotiating. You are going to want to create a list of all of the cash that is coming out of your account and being sent to your suppliers and software providers and any other automatic payments. Once you have the list created you can go back to those suppliers and ask to change the dates so that your cash is coming out at a better time in the month for you.
• Tactic C: Negotiate with financial institutions. In the early stages of business, a bank might hold cheques for several days between when you deposit and when the funds are available in your account. A payroll processor might hold funds for several days. A merchant service may delay settling credit card transactions into your bank account, so go negotiate better terms. They won’t come to you to offer it.

Final Cash Flow Tip

Once you have cash under control, or even almost under control, start creating a reserve fund. Park it in a separate bank account. Dedicate a portion of each month’s proceeds to it and build it up over time. That way you’ll have something to draw from for the next investment or the next rainy day. It’s true for personal finance and it’s true for business finance… but nobody does it. I know how to make it happen, and now you do too! Also make sure to find proper business accounting services to help you find and eliminate your accounting mistakes and walk you through tax deduction, etc.