The Australian Bureau of Statistics found that 60% of new business will fail within the first three years of operation, with the main cause of failure being due to a lack of cash. It’s no surprise then that proper cash flow management is vital to any successful business.
Xero’s Small Business Insights analysed data from their customer base and found that cash flow tends to move in cycles. On average, around 50% of all businesses operate with a negative cash flow throughout the year. With that in mind, here are the top five worst cash flow mistakes and how to avoid them:
1. Over-Estimating Future Sales Volume
Revenue forecasting goes hand in hand with cash flow management, and while it’s important to be optimistic, it’s sometimes more pragmatic to be realistic with your sales forecasting. The holiday period can be great for businesses and it’s not unreasonable to expect your sales volumes to increase. Expecting them to double or triple, however, could be a tad unrealistic.
Thinking your business will have more cash than it actually will, can throw off budgeting and hurt cash flow. That’s why it’s important to build a realistic forecasting model based on historical evidence and real numbers. Using historical revenue data from your own business, or even similar businesses in the same industry will let you create a basis for tracking trends and predicting future sales. This kind of information, along with market trend analysis, will help you come up with more realistic future sales projections.
Revenue forecasting can get a bit tricky for newer businesses without historical sales data to draw on. This is where working off any kind of industry data or market trends can be extremely useful. Regardless of your business’ age, it’s important to base your predictions on data and facts to avoid overspending based on ambitious sales predictions.
2. Not Being Proactive About Overdue Receivables
Unpaid invoices are cash-flow killers. One of the worst things for a healthy business cash flow is overdue invoices, especially for B2B businesses. If you aren’t proactive with your payment collections, you could be leading yourself into a dangerous cash flow situation.
The average debtor period for Australian businesses is rising, so it’s important to have solid systems in place for collections as well as policies and even penalties for late payments. Your policies need to be clear and firm, without being so harsh that they cause your customers to look elsewhere.
Some common late penalties include a 5% late fee after five working days overdue, or work stoppage after 30 days overdue (for service-based businesses). Alternatively, some businesses offer discounts or incentives for early repayments.
Creating an internal system is just as important. Implement procedures for when the initial invoice is sent out, when payment reminders are sent and when collections calls and follow-ups need to begin.
3. Impulse Purchases
“You have to spend money to make money”. A very familiar saying, but not necessarily true all of the time. The mentality of ‘it will pay for itself’, has led many business owners to overspend on impulse business purchases – especially in the early stages of operation. When you are still in your startup or growth phase, you need to really weigh up all purchases and assess the value the asset will add to your business.
Not all expenses are created equal and it’s important to budget properly (and even conservatively) when looking at purchasing a new piece of equipment, product or another business asset. Calculate the cost of your purchase and use an ROI calculator to determine how much profit your new purchase will yield. Overspending on an impulse purchase without properly assessing how it will fit into your business can leave you in serious debt and even cause your business to go under.
Tying these calculations into your revenue forecasting and budgeting will let you see how long it will take the purchase to ‘pay for itself’ as well as when it will start contributing to overall profits. This way you will be able to keep a steady cash flow while you’re business is ‘paying off’ your purchase. With something like a piece of production equipment, these calculations will be relatively straightforward. However, with something more intangible, like a marketing campaign, it could be more difficult. Either way, it’s important to know both the cost of your purchase and value it will add to your business.
4. Tracking Your Cash Flow
You’re setting realistic sales forecasts, being proactive with your collections, and practically assessing your business purchases. You’re now well on your way to doing wonders for your business’ cash flow. One of the last things to start doing (if you’re not already) is to track your day-to-day cash flow.
When building your budget it’s important to look at your inflow of revenue and outflow of expenses during a particular period rather than just your static capital and assets. If you’re tracking your daily cash flow you will be able to identify trends, either weekly, monthly, quarterly or even yearly, and anticipate when your cash flow will peak and trough.
Using a cash flow statement when budgeting will let you plan ahead for those difficult periods when you know cash flow will be tight. It will also let you take advantage of periods of high cash inflow and capitalise on any extra sales opportunities.
5. Not Having a ‘Cash Cushion’
No matter how carefully you budget and how many safeguards you have in place, hiccups in your business’ cash flow are inevitable. However, these hiccups might not be so damaging if your business has a cushion of savings to fall back on. On the flip side, if you don’t have any cash reserves then a slow sales month could be disastrous.
As a general rule of thumb, it’s good to keep to keep a cash cushion of at least two months of business operating expenses. This can vary from business to business, but every business owner should have some sort of cash reserve. This way, even if you do experience a slow down in your cash flow, you have reserves in place to protect your business.
Cash flow management can be a tricky, particularly for newer businesses without cash reserve or historical cash flow data to measure from. Even if your business does experience cash flow hiccups, there are ways to smooth out gaps and keep business operations running smoothly. A lot of businesses use short-term working capital loans to bridge gaps in cash flow during slower periods. This way your business keeps the cash flowing during slower periods and won’t miss out on any potential sales due to lack of working capital. Learn more about unsecured small business loans from Moula.
