When small and medium-sized enterprises (SMEs) suffer from cash flow difficulties, it’s not just small business owners who feel the brunt of the issue. SMEs are some of the main driving forces in the Australian economy. A 2020 article from McKinsey pointed out that companies in this category employ about two-thirds of the country’s workforce.
Managing business cash flow is no minor goal, either. The office of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) stated in a recent report that insufficient cash flow was the prime driver behind business insolvency.
Unfortunately, cash flow issues can be an all too common challenge for SMEs. In order to maintain your company’s financial well-being, it’s important to anticipate the frequently occurring causes that can lead to future problems with cash flow. Sometimes, proactive measures will help you avoid potentially negative outcomes. In other instances, you’ll have to respond carefully and strategically to ensure the continued success of your SME.
What cash flow issues should small businesses look out for?
If you manage an SME, you should prepare for unexpected cash flow issues whilst planning to handle more predictable roadblocks that can also affect your cash flow.
In general, small businesses would be well-advised to watch out for potential challenges like:
- Overdue invoices.
- Submitting late payments.
- Spending too much, too early.
- Inaccurate forecasting.
- Sudden crises.
1. Inbound cash flow difficulties: Overdue invoices
A December 2020 ASBFEO report on the state of small businesses noted that late payments and longer payment terms were having a negative impact on cash flow. As SMEs record current assets among their accounts receivable, they may appear at first glance to be in good financial standing, but steady cash flow relies on those outstanding invoices actually being paid.
Occasionally, an SME’s customer won’t pay their bills on time. It happens. This still has a negative impact on cash flow, but it’s not the worst-case scenario. In other instances, the client won’t pay at all. For these situations, the receivable becomes bad debt. If an SME doesn’t have the cash reserves necessary to weather the problem, they’ll have to make up the deficit elsewhere.
Late incoming payments can be particularly challenging for an SME early in their history, especially if they don’t have a broad customer base. With most of their revenue coming from a small pool, the business could be left vulnerable if their partners run into difficulties of their own.
2. Incurring penalties: Submitting late payments yourself
Oftentimes, it can be beneficial for SMEs to receive incoming payments quickly while paying their own suppliers later, increasing the amount of cash they have on hand at any moment. Given the nature of your business, it may even be necessary for you to negotiate a distant payment horizon with your supplier, allowing you to sell sufficient inventory to cover your costs and achieve a stable level of working capital.
However, your suppliers might not be willing to accept the longer payment terms that your business demands. This means that you could jeopardise your margins by submitting payments on time, or, alternatively, you could pay them late, damaging the relationship and leading to additional fees. Those extra expenses will also inhibit your cash flow.
3. Failure to be frugal: Spending too much, too early
It takes a lot of money to start a business, especially when you’re building the entire operation from the ground up. But how much money does it actually cost? As they launch new companies and projects, some SME leaders fail to rein in their spending, putting them way behind in the race to profitability. In addition, they may fail to realise how their initial purchases may set them up for higher ongoing overhead costs, leading to chronic cash flow problems down the line.
To make sure you start your enterprise off on the right foot, business.gov.au — a free government-sponsored resource for businesses — has a tool to help you calculate your startup costs. On this site, you’ll find useful information about researching costs you may incur and how to create a list of expenses for your new operation.
As SMEs grow, they’re liable to experience turnover, too. It can cost a lot of money to find and train new employees, and lost productivity in the interim can also inhibit cash flow. Look to hire reliable workers who want to grow with your company, and strive to retain them for the long term.
4. Missing the mark: Inaccurate forecasting
Cash flow forecasting is a difficult process to get right. Inaccuracies in your estimations can produce financial missteps that result in your SME being strapped for cash for an extended period of time. The problems could potentially cascade from there.
Challenges arise in the form of siloed accounting systems, inaccurate or insufficient data, or in a failure to truly understand the timeframe for sales cycles in your business, especially for new companies. Conservative forecasting and strong reserves are crucial.
5. Expecting the unexpected: Sudden crises
One of the keys to resilience is to anticipate disruption. In an instant, everything can change. That was what happened with COVID-19’s impact on cash flow. Suddenly, businesses saw themselves balancing alterations to their supply chains, declining revenue and late customer payments.
No matter how well you prepare for your SME to handle common cash flow disturbances, the ability to adapt to unforeseen circumstances is still instrumental for ongoing success.
How might a business deal with cash flow problems?
Given how pervasive cash flow problems are, it’s very possible that, without leveraging additional solutions, you may encounter these issues at some point in the life span of your SME.
This is especially true for companies that operate in industries with slim profit margins. Those with higher margins may enjoy more flexibility, especially over time. But for companies in which revenue barely exceeds operating expenses, any late customer payment can potentially strain your ability to pay your own suppliers on time.
Fortunately, there are several steps you can take to deal with cash flow problems, such as:
- Preparing in advance for the common issues cited above: Diversifying your customer base and establishing a cash reserve to cover overdue invoices can help you weather delayed customer payments and preserve cash flow. Carefully budgeting your startup expenses and remaining thrifty as you get established can set your SME up for solvency.
- Improving your cash flow analysis: It may take a lot of work, but making sure that you have accurate analyses and forecasting processes will go a long way toward ensuring steady cash flow. Below, we’ll explore some specific problems you may unearth after improving this process.
- Exploring additional funding and finance opportunities: Creative solutions like flexible Buy Now, Pay Later solutions can help you expand the payment terms for your own suppliers whilst enabling prompt payment from your customers.
What problems can you uncover with a cash flow analysis?
A cash flow analysis can help you determine the rate at which cash enters and exits your business. By carefully assessing this financial information, you can determine the normal operating state of cash flow in your business. If it appears that your flow is restricted, a thorough analysis will help you pinpoint where the trouble is occurring so you can decide on strategies for addressing the problem. Depending on your unique circumstances, you may discover that:
- Cash flow issues are emerging in your SME due to delayed inbound payments.
- Your timeframe for paying suppliers is too narrow, and it needs to be expanded.
- Too much of your money is tied up in trading stock or ongoing expenses, meaning that you should trim overhead or reduce your inventory further before purchasing more.
How can your business deal with cash flow problems?
Based on what you discover about the origin of cash flow problems in your business, you may be able to handle the issue through revising elements of your operations. Minimising unnecessary ongoing expenses or altering your purchase volume may be effective.
If you don’t have the financial expertise to conduct this kind of analysis in house, working with an hourly outside chief financial officer (CFO) can help. Many companies rely on an outsourced CFO to provide support as needed.
For other cash flow management issues, specialised financial products may be necessary. Especially for SMEs, it can be difficult to secure traditional loans, even with substantial collateral. Using the support of these services, you can free up liquid assets to reinvest in your company and grow your SME’s operations.
Be wary of high-interest short-term loans, which can carry interest rates in excess of 20%. Not only are they expensive, but these financial tools may also negatively impact your credit, making them an unwise long-term solution.
1. Line of credit
You may be able to leverage a business line of credit for rotating access to reserve funds. This can be helpful as a short-term solution in some scenarios. However, the interest terms can often prove prohibitive, and more cost-effective solutions are probably preferable.
2. Invoice financing
Invoice financing, whether in the form of factoring or discounting, is a cash flow solution that allows established businesses to borrow against outstanding invoices from their accounts receivable.
There are some drawbacks to this approach.
With invoice factoring, in particular, the financier handles payment collection, which may not be desirable in terms of maintaining the customer relationship. Invoice discounting is often reserved for companies that are already in a strong financial position. These services may be difficult to arrange for SMEs that don’t have a substantial history they can use to demonstrate their reliability.
3. Buy Now Pay Later solution for business
The UnLock ‘Buy Now, Pay Later’ is an ideal solution that facilitates extended payment terms for buyers and suppliers of all sizes, including SMEs.
Local and international businesses are able to sign up quickly and the approval process is simple. From there, buyers upload an invoice to UnLock. The supplier will be paid within 24 business hours whilst the buyer selects their own repayment terms, which can range from 30 to 90 days. The whole process is easy, accessible and affordable.
With the UnLock solution, SMEs are able to customise their payment terms and improve cash flow. If the company is struggling to compensate its suppliers on time, UnLock can expand the payment window. If the business is suffering due to late payments from B2B customers, the SME can sign up as a supplier and encourage their clients to use the platform. The supplier benefits from prompt payment in full while their customers enjoy flexible terms.
Why do small businesses fail?
It’s not for a lack of passion, effort and enthusiasm that an unfortunate number of small businesses fail. In fact, for many entrepreneurs and SME managers, their business is the realisation of their deepest aspirations.
Still, poor cash flow can hinder success and temper growth even for profitable businesses.
Without proper cash flow management, companies are unable to expand their operations, reinvest in growth areas or survive sudden obstacles and unforeseen disruptions in the marketplace. Not only that, but problems arising from cash flow issues can make it difficult to maintain normal business operations even under the best of circumstances. SMEs need to have sufficient cash on hand to pay their employees, maintain their facilities and acquire new inventory.
With the right planning in place and the support of innovative solutions like the UnLock Buy Now, Pay Later solution, SMEs can preserve optimal cash flow levels.