What is a “cash flow crunch”
and how to avoid it?
Whether a business is rolling along at full speed or barely managing to hang on, a “cash flow crunch” can bring it to its knees in a very short time span. In this article, we describe warning signs for a cash flow crunch and how MyCFO can help your clients.
Newer businesses may find customers flowing through the doors, demand rising, inventory growing, staff getting trained – all good things, yet there is very little cash! Mature businesses can find that market or seasonal changes can bring about sudden, dramatic changes that have never been encountered – and cash is also scarce!
The phrase “cash is king” never seems more appropriate than at those times. If a business doesn’t have enough cash reserves or a sufficient working capital line of credit, it can go upside down in a hurry. A sudden, unexpected cash flow crunch can demolish an unprepared or mismanaged business.
What is a cash flow crunch?
Simply put, cash flow is the inflow and outflow of money from a business. It is necessary for day-to-day operations, funding payroll, paying vendors, purchasing inventory and other operating costs.
“Positive cash flow” is when a business has more money coming in vs. going out; over the long-term, this is how value is created shareholders. “Negative cash flow,” is when more money is flowing out from the business in the form of accounts payable, debt and interest payments, payroll, rent and other expenses.
A “cash flow crunch” occurs when a condition of negative cash flow is substantial enough to impact operational functionality, either for a short or sustained period.
This is also known as a “working capital crisis” – working capital is the difference between a company’s current assets (e.g., cash, accounts receivable, inventories of raw materials and finished goods), and its current liabilities (e.g., accounts payable and debt payments). The crisis occurs when this becomes negative vs. positive.
What causes it? What are the warning signs?
There are many causes for a cash flow crunch – and perhaps surprisingly, not all of them are what we might consider “bad!” Instead of being surprised, management can understand the warning signs of a potential cash flow problem and then prepare for or avoid them.
>> Check the “warning signs checklist” below:
Revenue issues:
• Low sales volume
• Rapidly expanding sales volume
• Market and seasonal fluctuations
• Allowing too many accounts to become past-due receivables.
• Reliance on receivables concentrations (i.e., big customers) who pay late.
• Offering too many customers delayed payment programs.
Expense items:
• Gross margins are too low
• Slow moving, obsolete inventory
• Net margins are too low (operating costs are perhaps out of control)
• A long lead-time between raw materials purchases and finished goods.
• Losing out on discounts with suppliers and vendors
• Employees are not operating near maximum productivity.
• Plant or offices are too large, causing waste of resources.
Cash and debt concerns:
• Inadequate cash reserves
• Lack of sufficient working capital line of credit
• Over reliance on short-term debt to fund cash flow
• Funding fixed with short-term debt or current assets with long-term debt.
A cash flow crisis can be devastating. Unfortunately, entrepreneurs who have never encountered these problems get “taken by surprise, even when the business seems to be going great. It is a sad fact that such as crisis can cause a business to fail very quickly, finding itself in bankruptcy.
How to avoid or fix it?
Avoiding a cash flow crunch is obviously a lot easier than fixing it after it occurs. Planning for working capital cycle is an essentially part of running a business, day-in and day-out. It should not be considered a measure only for times of crisis!
Fortunately, MyCFO can usually help a business in either situation (dire or day-to-day operations). The professionals at MyCFO would be pleased to discuss how we can help your client’s business in managing cash flow. Contact us today to learn more!