Cash is the lifeblood of a business. Strong cash flow is a marker of a healthy business that is thriving. How important cash and finance is to any business does not need any description. Frequent phrases like, “Cash is King” and “Turnover is vanity, profit is sanity and cash flow is a reality” succinctly state the importance of this particular resource. The question is, however, why do many businesses, despite having a strong financial foundation and good initial investments fail? The answer lies in their cash flow.
Having cash is not the only factor that spells success for a business. It’s a positive cash flow that ensures its actual success and continuity.
A study conducted by the U.S. Bank stated that poor cash flow management caused the failure of small businesses up to 82 per cent of the time. This is an extremely high percentage that shows that not only there is a lack of proper cash flow management, but also a lack of proper financial understanding among small business owners.
While it is understandable that not all entrepreneurs or business owners might have a strong knowledge of how cash flow, also known as working capital, works, it is still expected that they make financial decisions keeping the future in mind.
Decisions that might seem small, such as stocking up inventory, might not be that easy, at all. It might look lucrative to stock up when you have cash in hand, but when the inventory is not sold out and is held up then that amounts to pure cash or working capital that is held up, as there is an opportunity cost attached to the inventory sitting idle. Till you sell your inventory, your cash flow is locked in it.
In short, maintaining continuous liquidity (cash flow) is a matter of utmost priority for any small business owner or the finance manager of an SME business or start-up.
What is Cash Flow?
Cash flow is what is left of revenue once the business has paid off its daily expenses. It is the cash that’s available to service the debts of the business. Hence, cash flow is an extremely important component for lenders when lenders are reviewing loan applications. It might often take precedence over other components such as creditworthiness, character, capital, and collateral, as cash flow gives them a clear idea as to the business’s ability to pay the debt back, along with interest.
How do you calculate cash flow?
Cash flow = Net income/Net loss + depreciation/amortization + interest paid on debts
It is recommended that businesses have a dedicated accountant who can maintain financial records that reflect the true status of the business’s financials. If lenders find any discrepancies between the records and the true financial status of the business, there’s a high chance that they will not approve the loan application.
Ways of managing negative cash flow
The fact is, an SME could even sustain a few losses in its business, but a negative cash flow that does not allow the business to address its immediate needs could spell the end of it. By managing expenses, maximizing margins, and building a steady customer base, thereby ensuring steady revenue, small businesses and SMEs, alike, can ensure a positive cash flow balance.
Although businesses can secure a loan to start their venture, traditional banks are not too keen on handing out working capital loans to SMEs. This is primarily because of the risks involved in financing a business which already facing working capital shortages and also the huge underwriting costs involved in each such loan. Not to forget, the amount involved in these loans is lesser than what banks would want to invest their resources in. The gap in technology and high regulatory capital requirements also add to the risk factor. So, while businesses can apply for working capital loans at banks, there is no guarantee that the loan will get through.
However, by taking the right in-house measures, SMEs can ensure they do not fall into the crevice of negative cash flow and fall through to hit rock bottom from there. Here are some of the reasons why SMEs might face negative cash flow and ways they can manage them.
One of the most common reasons that lead to negative cash flows is when payables are more than receivables. Low sales and not receiving invoice payments on time could lead to lower receivables. By negotiating their payment terms, SMEs can improve their cash flow.
Businesses facing negative cash flow can revise their payment terms. They could request their customers to make payments within a 30-days window while they could ask their vendors to provide them with a 45 to 60-day window to make the invoice payments. This gives the business enough time of around a fortnight to a month to go back to its cash-rich position and pay the vendors back. This also ensures that businesses do not have to go for working capital loans thereby adding the interest component to their payables, as well.
However, if the receivables are low themselves and the business is facing low sales, opting for a small business loan or a working capital loan could be helpful. Business owners must check the interest rates before they commit to the loan. Business credit cards to pay for regular expenses are also a good option. Care must be taken to see that the credit is paid back at the earliest so that the business does not keep accumulating as a debt component.
To reduce expenses that might be leading to higher operating costs, businesses should ensure they are not paying more for the goods and services they need to run their business. In case of losses or low sales, selling off inventory at a discounted price can help cash flow and also attract new customers in the process.
Disruptions in fintech have not only helped SMEs get started with their business but also manage their finances and cash flow easily. In fact, according to the World Economic Forum, fintech start-ups are set to bridge the massive $2 trillion funding gap that exists for SMEs, worldwide. Fintech has the technology to its advantage and also a lot of monetary resources that are ready to be deployed to small business owners who need the financing to keep their business afloat.
By studying their particular needs and creating custom solutions for their cash flow problems, fintech companies have come a long way in solving negative or poor cash flow issues for SMEs. With tools like invoice factoring, supply chain financing, and equity crowdfunding, these P2P lenders are also set to give SMEs the financial boost they need.
Businesses have been in existence forever, so have the issues they have faced with financing requirements. However, thanks to technological innovations new age entrepreneurs have a lot of options at their disposal to help manage the cash flow situations of their businesses. Based on the reason that’s causing negative cash flow, small business owners can opt for the fintech lending platform that they deem is most suitable for their particular need.