What oxygen does for our bodies, cash flow does for a business. A prolonged cash shortage can bottleneck your company’s financial health, and in the worst case, it may result in insolvency. This is why it is crucial to maintain your company’s cash flow to stay afloat. While there are many reasons a company might suffer from a cash shortage, the problem becomes inevitable when cash outflows outweigh cash inflows for an extended period. Fortunately, there are ways to predict a company’s cash flow and optimize it so you never have to face any cash shortages. This blog will uncover some common reasons for cash shortages and also discuss the strategies to overcome them.
Understanding Cash Shortages
When a company’s cash outflow or expenses exceed cash inflow or income, it is often challenging to cover its running costs which results in cash shortage. There may be many reasons, some controllable and some uncontrollable. Here are some of the common reasons for cash shortages.
- Declining demand for products
- Strong competition in the industry
- Delivery issues or low quality of products
- Customers delaying payments
- Inefficient accounts receivable collections strategy
- Clunky systems to manage cash flow
All the above reasons may lead to cash shortage and if not managed on time, it may lead to bankruptcy. While you cannot control strong competition or inflation, by managing controllable features effectively and efficiently, you can navigate those issues. Through accurate planning and cash flow management, you can ensure that your business doesn’t face bottlenecks in the first place.
Common Culprits of Cash Flow and Their Consequences
Regardless of size or industry, cash flow shortage can affect any business. However, they are more likely to affect small and medium businesses because they have shorter cash reserves. Things become a major headache for startups and entrepreneurs and their finance teams including accountants. Here are some of the common cash flow problems that must be avoided.
1. Payment Delays and Overdue Invoices
Businesses running on a credit sales model often rely on customers to make timely payments. Since the businesses rely on invoice payments as their income, it isn’t always on time. Even the payment processing takes time for businesses using clunky processes. This necessitates your finance teams to reach out to customers and remind them to pay invoices which is a time and resource-draining practice. Businesses embracing accounts receivable automation solutions can navigate these issues by streamlining their collection processes. This saves time by accepting electronic payments, making it more efficient to collect and use funds, as payments settle into your account in no time.
2. Lower Cash Reserves
Businesses often face complexities due to inflation, or any mishap which requires cash injection to overcome the situation. For those with cash flow reserves can navigate such situations by funding a new project, or plan lucrative investments. However, things can get out of hand for businesses with lower cash reserves. These businesses often acquire loans or use invoice factoring for an instant cash injection. This issue is common among small businesses and startups with limited cash reserves, and if they cannot sustain it, it may lead to business insolvency.
3. Lower Profit Margins
There are many reasons for shrinking profits. Businesses often experience lower profit margins due to lower-priced products. Conversely, if your prices are too high, you may face the same outcome. Reduced profitability hinders your ability to fund operations and can lead to friction. If not addressed promptly, the consequences can be severe. Lower profit margins indicate a need for additional funds and cash inflow, further complicating the situation.
4. Employee Dissatisfaction or Change in Demand
If employees prefer your competitor’s products or services, it may be due to better product quality or changing customer demand. In the consumer goods sector, demand often changes suddenly. Similarly, customers in the service industry seek frictionless experiences, such as quick and easy purchasing and checkout processes. You can enhance customer experiences by accepting electronic payments through credit cards and ACH payment processing, which are faster and easier to adopt. Implementing these changes can help you meet customer demands and retain their business.
5. Disorganized Bookkeeping
When businesses rely on clunky systems for an extended time, they often find resistance to change and the consequences can be drastic. With messy bookkeeping, you cannot understand the cash inflow and outflow, preventing you from effective planning. These disorganized accounting practices may also cause friction with the auditing process, as you cannot clearly see the expenses, overheads, and hidden costs. Ensuring good bookkeeping practices is a way out as it can protect you from accurately computing your cash going out and coming in, all while enabling you with an accurate snapshot of your company’s financial health.
Practical Strategies to Overcome Cash Shortage
For businesses already experiencing cash flow shortage, they must take action to inject cash to prevent business insolvency. However, businesses with severity of cash shortage can employ the following practical strategies.
Shorten Invoice Payment Period for Customers: It may take between 30 and 90 days to get paid, depending on the industry which is one of the common cash shortage reasons. Getting paid quicker can help you overcome cash flow shortages. Therefore, you need to reduce the invoice payment time to 30 days or offer customers with early payment discount to prompt payments. This approach can help you get paid with the shortest possible payment terms without frustrating your clients.
Extend Supplier’s Payment Terms: Since you are short on cash, you must negotiate with your suppliers to extend your payment terms. This will give you more time to get your hands on cash, receive customer payments, and pay your suppliers. If the supplier is not accepting, explore other suppliers with the best possible payment terms.
Consider Invoice Factoring: This is one of the best rescue approaches if your customers frequently delay payments. With invoice factoring, you can get paid immediately by a third party that charges a fee per invoice. Nevertheless, having immediate cash on hand can help you avoid penalties, pay your vendors, and settle your payroll, allowing you to operate smoothly.
Prevent Cash Flow Shortage in the Future
For businesses and startups anticipating cash flow shortages, here are some best practices to consider to prevent such issues and maintain steady cash flow.
Building up Cash Reserves: Many small businesses and startups seek immediate growth. While investing in a lucrative initiative can boost your business, it’s important to build cash reserves for at least six months if any risk is involved. This precaution can help you manage cash flow shortages and give you enough time to recover without relying on interest-bearing loans.
Monitor Your Business and Cash Flow: Investing in systems that enable accurate and frequent cash flow monitoring can help you prevent shortages and predict your future cash flow. This can also assist in planning, allowing you to foresee and prevent any cash shortages several weeks in advance, giving you more time to take proactive measures.
Employ Automation Solution: Implementing advanced solutions that help you streamline your workflows and improve your efficiency can also prevent you from the cash flow shortage. These platforms empower your business with cash flow optimization, invoicing, and collections so you can save time on cash flow management while also keeping an eye on performance indicators to get a clear snapshot of your organization’s financial health.
The Bottom Line
Businesses, startups, and entrepreneurs may face cash flow shortages due to a variety of factors, including both self-inflicted issues and uncontrollable elements. Relying on outdated systems and failing to track your cash flow can contribute to these shortages. This blog highlights common causes of cash flow problems and their consequences. It also presents practical strategies for overcoming and preventing cash flow shortages, helping you effectively monitor your cash flow and take proactive measures.
Keep an eye for more news & updates on Gossips!
