Running out of cash is a common problem in business. Companies often misjudge their spending or get the timing wrong and find themselves in the red unexpectedly, unable to make the progress they would like.
But what goes wrong, specifically? That’s the topic of this article. We look at some of the reasons the money pot runs dry and what companies can do about it to improve their financial position long-term. Here’s everything you need to know to prevent this issue from affecting you in the future.
Inefficiency Issues Relating To Operations
One problem that can catch some business owners out is inefficient operations issues, particularly when a company is new. These issues raise the amount your company has to spend just to get jobs done, which can exceed what financial planners in your team expect.
Supply chain issues are the most common problem at this stage. It often costs a lot to procure products and raw materials when a company is new because of insurance or issues with buying, and these figures can add up to create problems.
Rising redundant tasks can do something similar. Having too many of these in production processes can lead to problems with wages and spending too much internally, particularly in office settings.
Eventually, these inefficiencies add up and start creating serious issues for the business. Cash runs dry and more short-term borrowing becomes necessary.
You can deal with these inefficiencies by comparing sectoral spending to industry benchmarks. Working out where you’re doing well, and where you are spending less efficiently can highlight the areas you need to improve. Simply rearranging how you do things internally or investing in software often solves these problems and helps you get back to where you need to be.
Borrowing Too Much
Borrowing too much can also lead to serious problems with the amount of cash your firm has to spend on its operational requirements. Using some credit is often necessary, but when your loans are large, it increases repayment spending which, in turn, deprives the rest of the business of cash.
The most problematic loans are those that carry high interest rates. These are supposed to be used short-term but can affect a business in the long run if not repaid within a minimal time scale, preventing it from thriving.
The solution to this problem is to only borrow from high-quality investors willing to sacrifice short-term profits for higher returns in the long run. Sometimes this might mean offering them equity in the firm or allowing them to have a say in the company’s operations.
Problems with borrowing are the reason most companies work with professional investors and not conventional lending institutions. Having people on board who understand how your business operates and when it is likely to make a profit is essential.
Failing To Keep A Cash Reserve
You will also sometimes see issues arising when people fail to keep a cash reserve. Not having enough money on hand for things like rent and utilities can put pressure on business operations and prevent it from functioning the way you want.
These issues are most intense in the early phase of operations. High overhead can reduce cash reserves faster than they accumulate, preventing rainy-day spending and making it more challenging for the business to recover from sudden financial shocks.,
Solving low cash reserve issues is quite challenging because it competes with the need for your company to spend on essentials, like wages or new locations. The solution is often better financial planning by using encumbrance accounting software. The idea is to take account of future spending today so that you know how much money you will have available at any given point in the future.
If you discover that there will be periods going forward where you don’t have sufficient cash, you can start planning today. Borrowing more or spending less can prevent financial crunches and help you avoid cutting essential spending going forward.
High Overheads
High overheads are another common issue you might face when trying to manage costs at your company. If the amount you’re spending is too high, then you will whittle away at your cash reserves and find yourself experiencing cash flow issues in the future.
High overheads usually result from trying to purchase items that are too costly for your business right now. For example, you might believe your brand deserves a swanky downtown office but your financial situation means you can only afford something much smaller, like an out-of-town unit.
Other overheads that can get out of control include salaries, utilities, and spending on marketing. These can overwhelm your business if not managed correctly.
The trick here is to avoid spending money on items unless they are completely necessary. Auditing your expenses and accounts can help you determine whether you’re investing in things that are worthwhile or not.
You want to pay particular attention to this during slower business periods. Many companies get into trouble when they keep their spending high even in quiet seasons.
The best way to do this is to adjust your labor inputs. Taking on temporary workers at certain times of the year can help you avoid excessive costs.
Another option is to work with marketing agencies to ramp up outreach in the run-up to your peak season and then lower it again once it finishes.
Inventory Mismanagement
You can also run out of cash or harm your financial position with poor inventory management. Overstocking often means overspending and increases warehousing costs. Tying up money in products that won’t sell quickly reduces cash flow and makes the business a money sink, not something that generates funds rapidly. While your balance sheet looks healthy, your cash flow statements may not.
You can deal with these problems by ordering goods from suppliers only when customers demand them. While this may generate delays, it can also protect your cash position.
Another option is to focus more on products with high turnover and avoid keeping large stocks of those that tend to sell slowly. This way, you can keep the money flowing through your business and prevent excess stock from gobbling it up. If customers place a large order for a rare product, then you can order more from suppliers and apologize to them for the delay if there is one.
Being Too Optimistic About Sales
Overestimating sales is another way businesses get into trouble and run out of cash. Executives often believe there will be more demand than there is, leading to an inevitable crunch.
Higher sales are often achievable, but it takes time for companies to become established. Often, that means slower sales in the initial period and then faster sales later on, if the business survives. This phenomenon is usually predictable but requires being conservative about initial cash flow. It’s not often the case that consumers will begin spending money immediately on your company.
Again, you can place for these circumstances by using the proper accounting software. Working out realistic revenue projections shows you where you are today and where you’re likely to be in the future.
Slow Customer Payments
Slow customer payments can also cause harm to your business’s underlying cash flow. Patrons who take a long time to send money to you can undermine your ability to purchase the things you need.
The primary issue here is invoicing. Allowing customers weeks or months to pay means they will often forget or leave it to the last minute to advantage themselves.
Therefore, try to take payment upfront for work done. Many industries are changing to these arrangements to prevent the problems caused by trust-based models.
Another issue is generous credit terms. Allowing customers to take out loans or benefit from your accounts receivable policies often means that you don’t have cash to cover your expenses. There is often a gap between what people owe you and the cash you have available to spend on your business operations.
Poor Cash Flow Management
The final problem many companies face is the issue of poor cash flow management. Firms will often fail to track cash inflows and outflows, leading to liquidity issues in the long run. Money flows are lumpy, causing times of surplus and times when the funds simply aren’t available.
This problem is common across industries and something that affects most entrepreneurs. In fact, it is one of the top reasons why companies stop trading, even if they are profitable. The financial side of the business fails before the company becomes established, making it impossible to thrive long-term.
The key here is to use projections to identify cash flow at any given point in time. Such tools allow you to see when your brand is running out of money and how to plan for it.
Accountants do these types of calculations all the time. They look at your business from a financial perspective and then try to work out when you will need money. This approach shows you when problems are likely to emerge, allowing you to make better decisions today to prevent them.