Small business ownership and management are challenging tasks. According to statistics, the majority of small businesses fail during their first five years of operation. But why is this the case? A recent study by US Bank attempted to answer this question and discovered that inadequate cash flow management or a lack of awareness of cash flow was a key contributor to the failure of small businesses 82% of the time. This is a depressing statistic that emphasizes the necessity of properly managing and analysing cash flow for your company’s growth and stability.
In this article, we’ll delve into the top 2 cash flow problems facing small businesses today and provide insights on how to address and overcome them. Whether you’re just starting out or have been in business for a while, understanding and tackling these common cash flow challenges is crucial for the long-term health of your business.
Understanding the Top Reasons for Failure
According to U.S. Bank research cited on the SCORE/Counsellors to America’s Small Business website, the top reasons for small business failure are poor cash flow management (82%), insufficient capital (29%), a lack of a solid business plan (21%), owner inexperience (17%), poor execution (14%), competition (13%), and a lack of market research (8%). Overall poor cash flow management and insufficient capital are among the top reasons for small business failures, underscoring the importance of proper financial management and planning. By understanding and addressing these common challenges, small business owners can increase their chances of success and stability.
How Can Financial Ratios Help Identify Cash Flow Issues?
By using financial ratios, you can get a better understanding of your business's financial health and identify potential cash flow issues. By regularly tracking these ratios, you can identify any potential issues and take steps to address them before they become major problems. There are several financial ratios that can help you assess whether you're experiencing cash flow issues. Here are a few common ratios to consider:
- Current ratio:Â A current ratio of 1:1 or higher indicates that you have sufficient assets to cover your short-term debts.
- Quick ratio:Â A quick ratio of 1:1 or higher indicates that you have sufficient liquid assets to cover your short-term debts.
- Debt-to-equity ratio:Â A high debt-to-equity ratio may indicate that you’re relying too heavily on debt to finance your business, which could be a sign of cash flow issues.
- Cash flow coverage ratio:Â A ratio of 1:1 or higher indicates that you have sufficient cash flow to cover your debts.
By regularly tracking these financial ratios, you can identify potential cash flow issues and take steps to address them before they become major problems. It's also a good idea to consult with a financial professional to get a more comprehensive understanding of your financial health and identify any potential cash flow issues. By taking a proactive approach to financial management, you can ensure that your business has the resources it needs to thrive.
How do we tackle the cash flow problem?
To tackle the issue of difficulty in cash-flow issues and forecasting, you can try the following strategies:
Cash-flow issues
Classify your expenses.
Knowing precisely what you are spending and where it is going should be your first move. Organize your expenses according to G&A, R&D, Sales & Marketing, Operations, and COGS, then look for any remarkable ones. As you consider whether the cash allocation makes logical, take note of the percentages that each category spends.
By categorizing your spending into these categories, you can get a better understanding of where your money is going and identify areas where you may be able to cut costs or increase efficiency. This can help you better manage your cash flow and ensure that you have the resources you need to run your business.
Comparative financial analysis
You should have a clear understanding of how other companies spend money and use those examples as benchmarks for your own spending. Take into account both businesses in your industry and those that are at the same stage of development as your company.
By comparative financial analysis of your business's cash flow performance, you can easily identify opportunities to improve and make informed decisions about how to manage your cash flow more effectively. Remember that you don't want to spend more money than you have, so ignore benchmarks and instead make adjustments based on the cash you have on hand.
Manage Your Spending Expenditure
While it is true that it takes some initial investment to generate income in a business, it's important to be mindful of how you spend your money. Every dollar spent reduces your profit margin, so it's crucial to carefully consider the pros and cons of each expenditure, particularly in the early stages of operation.
Not enough money
Not having enough money can be a real challenge for small businesses. When you can't pay your bills with the money in your accounts, it's essential to have a plan in place for getting paid. Otherwise, even the most successful companies can run into financial trouble if their funds are tied up in unpaid invoices. To avoid this, develop a system that ensures you receive timely payment from clients and be cautious not to spend more money than you have on hand.
2.Forecasting
Cash Flow Forecasting:
Establishing a budget based on a detailed forecast is essential to effective cash flow management . In order to support sustainable growth, companies should combine thorough forecasts with careful analysis of costs and benefits. By taking these steps, they can better understand their financial needs and make strategic choices that help them achieve their goals.
To Better cash flow management, small businesses can use specialized software that helps them make informed decisions about cash management. By using this tool, they can better plan for future financial needs and avoid cash flow shortages.
Overhead Costs:
Small businesses often have to balance overhead costs like rent, utilities, and other expenses against cash in the bank. If these costs become too large compared to cash on hand, it can lead to cash flow problems. To prevent this, small businesses should consider paring down their overhead costs and investing in cash management strategies that can help them stay on top of cash flow needs.
The concentration of clients in a small number
If the business relies heavily on a few key clients for a significant portion of its revenue, a disruption in one of these relationships could have a major impact on cash flow. This is why it's important for businesses to diversify their client base and avoid relying too heavily on any one client. By doing so, they can reduce their risk of financial difficulties caused by a disruption in a key client relationship. It's also important for businesses to have a cash flow forecasting plan in place to anticipate and prepare for potential disruptions to their revenue streams. This can help them maintain financial stability and avoid cash flow problems.
How can IBN Tech assist you?
Are you looking for ways to support sustainable growth in your business? Do you suspect that you may be facing cash flow issues, but you’re not sure how to address them? We have a team of experienced CFOs at IBN Tech who can assist you. Additionally, IBN Tech has more than 23+ years of expertise and proficiency working with more than 200 clients in the areas of integration, controller services, bookkeeping services, and accounting systems. Let us help you achieve long-term success for your business by controlling its financial health.
Conclusion
A major issue source of cash flow in small businesses is the inability to estimate and manage revenues, which can result in unstable finances and unpredictable cash flow. To address this, it’s important to have a clear understanding of financials, including a budget and financial projections, and to diversify revenue streams and smooth out fluctuations in sales. To overcome this, it’s important to communicate clearly about payment expectations, follow up promptly on overdue payments, and have a system for invoicing and tracking payments.
