Cash flow problems are among the main reasons for the failure of new businesses, although they can be controlled through better planning and implementation.
If passion, commitment, and planning are more important than money, then why do cash flow problems appear at the top of the list of reasons why businesses fail? Think of it this way: money is not needed to conceive a baby, but once a baby is born, it needs to be fed — and the bigger the baby gets, the more food it needs. So it is with a business.
Too many entrepreneurs confuse the word cash with the word profit, thinking they are one and the same. “Profit” is a word for accountants. “Cash” is what a business feeds on in order to survive.
One of the most difficult things to explain to aspiring entrepreneurs is that profitable businesses often end up going bankrupt because of cash flow problems, mainly because much of the business world operates on credit.
Even a business with $20 million in sales can face bankruptcy if it cannot meet its payment obligations while waiting for customers to pay for what they purchased. Suggestions for improving cash flow include:
Don’t Go on a Spending Spree During the First Year or Two of Operations
No matter how successful your business appears, or how enthusiastic you are to make improvements, the first year of operations is not the best time to spend money. It is the time for collecting money. Avoid the temptation to celebrate or spend heavily during the first year or two of operations.
Avoid Bad Customers
Before extending credit to anyone, ask for and check credit references. Some banks will do this for you, or you can conduct an internet search.
In the UK, the Better Payment Practice Group (BPPG) once named and shamed 10,000 delinquent companies on its website. The worst offender on its 1999 list was WorldCom — a company that took an average of 256 days to pay its suppliers and went bankrupt three years later.
In the USA, businesses can contact Dun & Bradstreet for credit checks and reports. Credit-checking services are available in most countries, so take advantage of them.
Bill Promptly
Whenever possible, ask for cash upfront when selling a product or service. Otherwise, establish a regular billing system, clearly state your payment terms, and negotiate advance payments whenever appropriate.
Create Incentives for Prompt Payments
Offering customers a discount of 1% or 2% if they pay within ten days often provides a strong incentive for them to settle their bills quickly.
Reduce Inventory
Determine how much inventory your business truly needs and cut back on excess stock. Reducing the amount of money tied up in inventory frees up capital that can be used elsewhere in the business.
Consolidate Your Loans
If you have borrowed money from several different sources, consider taking out one larger loan to cover them all. This may involve extending your repayment period for another year or two, which could cost more in the long run, but it may help lower your monthly expenses and improve cash flow.
Learn to Barter
Sometimes products or services can be exchanged without money changing hands. For example, many years ago I convinced a gym owner to expand operating hours by bringing in students who needed internships. Local university rules prohibited paying interns, so any company that accepted one received free labor in exchange for providing work experience.
After advertising for and finding several volunteers qualified to give riding lessons, I created a profitable program that allowed these volunteers — none of whom could afford their own horse — to ride whenever they wanted in exchange for teaching customers how to ride. This arrangement also reduced the amount of time and money spent exercising the horses. As a result, I never had to pay instructors a wage, they brought in many new customers, and the business became profitable within six months.
Final Thoughts
Be very careful when managing your finances because business is all about money flow. You should ensure that whenever money flows out, there is another stream of money flowing in to fill the gap. More importantly, the money coming in should exceed the money going out so that your business can survive and grow over the long term.