The longer the period of time from expense to collection, the larger the cash flowproblems the business may have. The longer it takes the more cash a business will require to cover its cash needs. What causes cash flow problems? Your cash may be tied up in your customer’s “pockets” through extended aging of accounts receivable or tied up in inventory that is not moving fast enough. In addition, your prices may be too low causing inadequate gross profit dollars. Gross profit dollars are used to cover overhead expenses, what is left results in net profit dollars before taxes. Your overhead expenses may be too high causing less gross profit dollars to flow into net profit. It could be one of these reasons or it could be a combination of these reasons causing cash flow problems.
Many have heard the saying that “Cash is King” in a small business, or in any business. A business must have cash to pay its bills. If it runs short of cash, they must borrow funds or inject outside or inside sources of cash, which may be difficult if the business is struggling. A business short of cash may be able to stall vendors and lenders for a bit, but payroll and most taxes are due on time. There can be serious consequences if they are not paid on time. For this reason, a business must make sure it has adequate cash on hand, and flowing in, to pay expenses and obligations that come due. Lack of adequate cash can cause constant worry and a lack of focus on other important business activities by the owners and managers. The uncertainty felt by the employees, who most likely know what is going on, can cause them to be unfocused regarding serving your customers.
How do you avoid a cash crunch? Run an industry financial analysis report for your industry, which can be done with the help of the SBDC. This information will tell you what the average business in your industry looks like in terms of accounts receivable turnover, inventory turnover, overhead expense percentage, gross margin percentage, etc. You can compare your numbers to industry averages and see where you are off the mark. If your inventory is too high, then you can look at your purchasing process and come up with ways of selling the overstock inventory and turning it into cash. If you are below average with accounts receivable turnover, then you can look at your credit and collection process to make sure future customers are credit worthy. You can ensure you have a good system of collecting what is due. If your gross margin percentage is below average, you can review your pricing and look at ways of lowering the cost of goods through better buying of goods or materials related to sales. You can review overhead expenses to see how you compare to your industry average. Reduction of unnecessary overhead expenses will lead to more cash available that will flow to net profit. This is a good exercise to do even if you are not in a cash crunch. Another problem that can cause a shortage of cash is fraud and embezzlement, which will be addressed in a separate article. The ASU Small Business Development Center can assist you at no-cost and confidentially by running an industry average report, assist in analyzing your situation and help you recover from cash flow problems.
“Business Tips” was written by Mr. Dave Erickson, Director and Certified Business Advisor, of Angelo State University’s Small Business Development Center. For more information on the topic of this article or the services of the ASU · SBDC, contact him at David.Erickson@angelo.edu.