Five Signs of Stress and Five Ways to Improve your Cash Flow
If income is the purpose of business, cash-flow is the lifeblood. Without cash, you can’t pay your bills, pay employees or buy inventory or materials. If you can’t pay your bills, it doesn’t matter how much money you are making on paper; your business is in trouble. Without cash-flow, you run the risk of becoming insolvent.
It is important that as a business owner you understand the inflows and outflows of cash and how they can affect your business. Let’s look at how cash-flow works: Usually, cash is made in a business through sale of your products or services, loans or owner investments, or asset sales. Cash flows out of a business through loan principal payments, business expenditures, owner withdrawals, and asset purchases. These cash inflows and outflows can be sorted into three main categories: investment cash-flow, operations cash-flow, and financing cash-flow.
Most importantly, you need to generate enough cash into your business to fulfill your pressing debts. During different times throughout the life of your business, you may generate the cash that you need in different quantities from the three categories listed in the above paragraph. At the beginning, you might produce cash-flow from financing (whether equity or debt), but after a while, unless you are a technology-driven firm looking to ultimately sell intellectual property, you are probably going to have to produce the majority of your cash-flow from operating activities (i.e. the sale of your products or services). Cash-flow that is operational is vital for the long term success of a sustainable business. Unless you are a technology startup eyeing a venture capital investment or acquisition, investing and financing aren’t feasible ways to run and develop your business long-term.
With operating cash-flow being the most important part of cash-flow to most businesses, it is of vital importance that you be able to spot potential cash-flow problems in order to take the steps required to avoid a cash-flow produced crisis. Below are five signs that your cash-flow is being stressed to the max and five ways that you can improve your operational cash-flow.
Five Signs of Cash-flow Stress
- Continued reduction in working capital – Unusually low balances in working capital accounts or abnormally high balances on working capital loans put you at high risk.
- Increasing accounts receivables as a percent of revenue –While credit terms may be a necessity of doing business, remember, you are not in the credit business.
- Escalating accounts receivable aging – Every day of aging A/R is another day without cash.
- An upsurge in average payables aging – Paying debts late is not only a sign of cash-flow problems, it is possible the debt will compound.
- Missing payments – This is your red flag; Take necessary action right away.
Five Ways to Improve Your Cash-flow
- Generate cash-flow forecasts – It’s important to be prepared, and understanding when money will come in and go out will help plan for this.
- Compare actual cash-flow to forecasts regularly – Reviewing your cash-flow situation on a regular basis will allow you to recognize and revise problems before they become major issues.
- Bill customers as soon as possible – The quicker you bill them, the sooner you will get paid. Never let billing be anything less than a top priority.
- Enhance your credit terms – Assess how your payables and receivable terms compare to each other. Look for ways to hurry up your receivables such as performing customer credit checks, offering discounts for early or pre-payment or charging late fees.
- Make sure to have a solid backup plan – No matter how well you are managing your cash-flow, there may be times of cash stress. Cash stress can even be related to good business developments like rapid growth or capital investments. While you shouldn’t chase bad money with good money, you should have a plan for supplemental cash-flow when needed. This will keep a cash-flow issue from becoming a crisis.