Have you ever walked into your home’s basement after years of neglect to find leaky pipes? Discovering your business’s cash flow problems is just like that. Recognizing the indicators that your business’s cash flow may be in trouble is crucial, as poor cash flow can affect the entire foundation of your business. Thankfully, with the right remedies, these issues can be resolved (if not avoided altogether!).
Early Warning Signs of Cash Flow Problems
Recognizing cash flow problems early can make a significant difference in your business’s financial health. Several sources highlight key warning signs that business owners should be aware of.
A decreasing cash balance is a primary indicator of potential trouble. C2FO points out that not being able to pay your bills on time is a major red flag, and in fact, notes that 82% of small businesses fail due to poor cash flow management. Forbes Finance Council also points out some less obvious signs, such as difficulty paying vendors on time or a decline in sales.
Being proactive and addressing these signs quickly can prevent more serious issues down the road.
What is Cash Flow?
Cash flow is the lifeblood of your business: it’s the money coming in and out of your company’s wallet. As defined by BDC, cash flow is the movement of money into and out of your business. It’s essential to monitor this movement to ensure you have enough liquidity to cover your obligations.
You may think that because you’ve sent out an invoice and that sum is recorded as a profit on your financial statements, you’re in the clear. However, if you’re still waiting for that payment months later and your bills are due, you’ll have a negative cash flow. You can appear profitable on paper, but if the cash isn’t in your hands, you’re in trouble.
As the proverbial “they” say: Cash is King!
Understanding Free Cash Flow
While cash flow is the general movement of money, it’s also important to understand free cash flow. This metric helps businesses understand how much cash they have after covering operating expenses and capital expenditures, which is crucial for investments and growth. Free cash flow helps determine how much cash a business has to expand, develop new products, or pay dividends.
Here are 3 key indicators that your cash flow is in trouble:
Indicator #1: You Have Overdue Accounts Receivable
As the owner of a growing business, there’s probably nothing that irks you more than your clients paying you late or not paying you at all, and rightly so. When cash is tied up in accounts receivable, you have less capital to work with to better your business or even to pay yourself. If your business is at the point where you have to borrow money to pay bills because of overdue receivables from clients, it’s time to reconsider your accounts receivable processes and policies, budgeting, and financial planning (or even your clientele!). When your money is tied up, you don’t have the working capital you need to use on investments, growth, and resources.
Your processes should include invoicing, maintaining a comprehensive history of your receivables and payables, and managing outstanding and historical transactions. By keeping a close eye on your liquidity and keeping a proactive collection process, you’ll avoid outstanding payments. You could also hire an accounting team like ours: we can resolve discrepancies related to accounts receivable, reconcile invoices, and process deposits.
Indicator #2: A Large Percentage of Your Revenue Depends on a Few Clients
It may seem great on paper: one or two clients who pay well and on time, but in reality, this poses a risk to your business. When a single client makes up a large portion of your business, your cash flow is dependent on them. Imagine your largest client, who accounts for about 40% or more of your revenue, goes bankrupt or is late with payments, or even decides to take their business elsewhere. It gets even more complicated when your clients change their payment terms and, as a result, affect your own payment cycle. How will you reconcile your negative cash flow with payrolls, bills, and expenses?
Strategically diversify your clientele base by expanding your roster of customers. By maintaining a balance of clients, you’ll reduce risk and achieve financial stability. Businesses that diversify in at least 2 ways (by client, product, service, etc.) are more likely to achieve strong financial performance. Always take a look at your balance sheet to see if your income is coming in from a single source, especially if your business is growing.
Indicator #3: Your Accounts Payable and Accounts Receivable Are Not in Sync
When your business is growing rapidly, it can be difficult to keep track of the money coming in versus the money going out. If your accounts receivable and accounts payable are not aligned with one another, you could be in trouble. If you’re constantly owing money at the same time you are owed money, you’ll find yourself continuously strapped for cash, potentially accruing unnecessary costs for things like increasing your line of credit.
Keeping track of your receivables is half the battle to be won: you need to know exactly when bills are due or when payments are owed, and create a collection process that keeps this delicate balance in check. Hire an experienced and reliable bookkeeper and/or an accountant to ensure that your accounts receivable and accounts payable are in sync.
Strategies for Improving Cash Flow
Cash flow problems are not something you can stick a band-aid on and forget. Once you’re in the red, it’s hard to bounce back. The key takeaways here are to:
- Keep a cash flow projection
- Stay on top of when payments are owed and bills are due
- No matter what, make HST and employee tax deduction payments (or suffer the consequences)
- Review your expenses constantly
- Create a budget with a safety margin to account for unexpected expenses
- Consider hiring an outsourced finance team to handle all of the above!
Our team at SBLR can keep track of your liquidity so you can focus on growing your business. We understand that as a business owner of an expanding company, you may not be able to give your undivided attention to the delicate balance between accounts receivable and accounts payable. That’s why we’re here to help. If you need help managing your receivables, payables, process deposits, and payments, we’re the team to turn to. Call us at 416-646-0550 or request a consultation to get started.