Poor cash flow – How to recognize it and how you can make sure it won’t be a problem
We know that the majority of small businesses fail within the first five years, but a recent study by U.S. Bank drilled down into the reasons why this occurs. In their study, they found that 82% of the time, poor cash flow management or poor understanding of cash flow contributes to the failure of a small business.
Why Small Businesses Fail
According to research done by U.S. Bank and cited on the SCORE/Counselors to America’s Small Business, the reason small businesses fail overwhelmingly includes cash flow issues. This includes poor cash flow management and poor understanding of cash flow, starting out with too little money, and lack of a developed business plan.
- 82% – Poor cash flow management skills/poor understanding of cash flow
- 79% – Starting out with too little money
- 78% – Lack of well-developed business plan, including insufficient research on the business before starting it
- 77% – Not pricing properly or failure to include all necessary items when setting prices
- 73% – Being overly optimistic about achievable sales, money required, and about what needs to be done to be successful
- 70% – Not recognizing or ignoring what they don’t do well and not seeking help from those who do
How do you know if you have a cash flow problem?
While there are multiple factors to consider with cash flow depending on industry and the lifecycle stage of your company, one key is relevant to all small businesses regardless of size or industry: If your expenses exceed your cash, then you have a cash flow problem.
It’s important to note that your expenses, especially during the early stages of growth, are most likely going to be greater than your revenue—you’re still trying to validate R&D, go to market, figure out sales and marketing, admin costs, and contractor relationships, etc. It’s also important to remember that your company will only be successful if you can eventually bring in more than you spend.
However, regardless of your lifecycle stage, industry, or plans for growth, your expenses should never exceed your existing cash.
If our small business has a cash flow problem does that mean we need to focus on selling more?
In an article authored by entrepreneur Tim Berry on Entrepreneur.com, he shares: “One of the toughest years my company had was when we doubled sales and almost went broke. We were building things two months in advance and getting the money from sales six months late. Add growth to that and it can be like a Trojan horse, hiding a problem inside a solution. Yes, of course you want to grow; we all want to grow our businesses. But be careful because growth costs cash. It’s a matter of working capital. The faster you grow, the more financing you need.”
Instead of “Sell, sell, sell,” how should we address cash flow problems?
There are several factors to consider before leaping to the “sell, sell, sell!” mindset to reverse a cash flow problem.
1. Categorize your spending. Your first step should be to know exactly what you’re spending and where you’re spending it. Categorize your expenses into G&A, R&D, Sales & Marketing, Operations, and COGS, and see if anything stands out. Note the percentage spends for each category, and analyze whether the cash distribution makes sense.
2. Benchmark. You should have a clear picture of how other businesses are spending and use those benchmarks to spend similarly. Consider businesses within your industry as well as businesses within your company’s lifecycle stage. Remember, you don’t want to spend more cash than you have, so regardless of benchmarks derived from other companies, adjust accordingly depending on your available cash.
3. Micromanage Your Spending. You’ve probably heard the saying “It takes money to make money,” but this common belief can cause new entrepreneurs to fall prey to gross overspending, especially during their first few months of business. While it does take money to make money, not all expenses are created equal. Remember that every dollar you spend is detracting from your profit margin, so especially during the early stages, it is important to consider the cost-benefit of every single expense.
Most importantly of all: Forecast
We’ve talked about the importance of forecasting before, and when it comes to cash flow, forecasts are no less important. Small businesses want to grow, and want to grow as quickly as possible, and a detailed forecast can make sure you can accomplish that growth in a sustainable and efficient way.
From implementing your benchmarking from point number 2 above, to knowing when to bring in extra cash from debt or equity financing, a forecast helps to take out the guesswork and put your business on a path of strategic advancement.
The Importance of Short- and Long-Term Forecasting
Cash flow is about planning, analyzing, and awareness
Creating a detailed forecast and using that information to drive a budget for your company is one of the most impactful steps your company can take toward intelligent cash flow management. Combining a thoughtful forecast with heightened awareness of your spending as well as the cost-benefit analysis of each expense means you will have the information and planning in place that can help you achieve more sustainable growth.
How can we help?
Are you unsure whether you have a cash flow problem, or do you want to discuss strategies for creating more sustainable growth? Schedule a free financial consultation with one of our experienced CFOs today or ask a question by clicking the button below.
About the Author
Michael Flint – CFO & Systems Advisor
Michael Flint is an experienced CFO with over 20 years in financial management. His expertise includes budgeting and forecasting, business process and systems improvement/automation, and technical accounting compliance. Michael is a VentureCapital.org Mentor and holds a Master’s in Accounting from BYU.
You may also be interested in…
An axiom in business that CEOs and founders must “know what they don’t know.” It’s rare that a CEO or founder has expertise in all arms of the business. Instead, they must rely on identifying their weaknesses and make strategic adjustments—usually by hiring someone...
The year 2020 has impacted businesses of all kinds in extraordinary ways, leading some to stunning windfall profits and others to utter ruin. This is especially true in the case of software-as-a-service (SaaS) companies. For instance, Covid-19 restrictions have kept...
On Sunday, December 20, Congress passed a $900B stimulus package. One week later, on Sunday, December 27, Trump signed the bill into law. While there are many aspects of the bill offering moratoriums on evictions and extending unemployment benefits, the bill also...
Preferred CFO has worked with hundreds of businesses from startups and small businesses to medium-sized businesses or businesses looking to fundraise. While many of these are companies experiencing high levels of growth, many are not yet in a position to afford or...
CFOs are high-level, strategic experts who optimize financial resources in a company while using those resources to achieve company goals more efficiently and effectively. Unlike bookkeepers, controllers, and accountants whose primary functions are rear-facing,...
It’s not uncommon to have difficulty differentiating between the main financial professionals. Not only are the names similar, but they are also often unintentionally used interchangeably. However, despite how the titles may be used colloquially, there are distinct...
When is the best time to make a new hire? Hiring too late can mean work (and clients) falling through the cracks; hiring too early can mean unnecessarily increasing your expenses. Payroll is one of the largest expenses a company will face, which makes the decision to...
It’s becoming increasingly common to see companies turning to an outsourced CFO instead of a traditional in-house CFO. This is especially true for the dynamic, high-growth SaaS industry. SaaS companies are finding that outsourced CFOs specializing in SaaS are often...
When your organization decides it’s time to bring in a new chief financial officer, is it better to hire a virtual CFO or an in-house CFO? When many companies think of CFOs, they default to the expectation of a long-term hire requiring an office, six-figure salary,...
Business Valuation Methods & Determining What Your Business is Worth Whether you're preparing for a sale or acquisition, seeking debt or equity financing, or evaluating other strategic business decisions, it's helpful to have a good pulse on the value of your...
On August 8, President Trump issued a Presidential Memorandum to defer the payment of the employee share of social security tax from September 1 through December 31, 2021. But what, exactly, does this Payroll Tax Deferral mean, and should employers take advantage of...
As Preferred CFO performs speaking engagements and advisory with CEOs around the country, one of the topics we’re continually asked to address is how to evaluate the quality of a financial team. Among these is answering the question, “What makes a great CFO?” We’ve...