One of the major causes of small business failure is running out of cash. There are many reasons why your business may face a cash crisis, and it is important to understand the factors that can cause cashflow problems.
No matter how healthy your balance sheet may appear in terms of the physical assets your business owns or the money that is currently owed to it, your ability to convert sales into actual cash at critical times may make the difference between survival and failure.
Late payment by customers
A sale is completed only when an invoice has been paid in full. Many business owners concentrate on generating new sales, and fail to set up adequate procedures to ensure that customers pay on time. As a result, they experience cashflow problems.
A key customer becomes insolvent
If your business is dependent on a few major customers, you are exposed to the risk of one of them having financial problems that could result in non-payment of an invoice. This can be disastrous if the income from that client makes up a large proportion of overall revenue, and is needed for your business to pay its own creditors or employees.
Insufficient working capital
Working capital is the money that finances the day-to-day operations of your business. When you first set up your business you are likely to face significant costs. You then have to pay suppliers and staff regularly before you actually receive any money from your customers. If enough money is not invested in your business when you set it up, you can quickly encounter cashflow problems once you start to trade as the cash flows out much faster than it is received.
You can also run into problems with working capital if your business grows very quickly. This is because as sales grow working capital requirement also grows. Money becomes tied up in stock and an increasing amount of money is owed by customers, who may pay more slowly than is needed for the business to pay its suppliers. This situation is commonly called over-trading.
Focusing on turnover instead of profit
Everyone wants to see their sales grow as quickly as possible but long-term sustainable cashflow into a business is generated only through making profits. Products that the business sells, and services that it delivers, should therefore be costed carefully to ensure that they generate a profit for the business at their expected selling prices. Focusing on high-volume but low-profit-margin sales can quickly lead to a position of over-trading if the working capital needs of your business have been underestimated.
Poor financial planning
Problems can occur if you do not make plans to ensure that you have cash to cover major expenses such as Value Added Tax (VAT), Pay As You Earn (PAYE) and National Insurance (NI) contributions, business rates and rent. You must take account of these payments in your cashflow forecast and ensure that sufficient funds will be available at these key times. It is also important to purchase any costly equipment when cashflow is stronger, or consider leasing equipment over a longer period to reduce the impact on cash reserves.
Over-committing with stock purchases
Wholesalers and other suppliers often offer discount incentives for bulk purchases, to encourage you to buy larger volumes of their goods. This may appear attractive at first, but careful thought is necessary before committing to large orders of stock, particularly for a new start up. A bulk order for items that quickly go out of fashion or have a short shelf life might mean being left with unsaleable stock that still has to be paid for.
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