9 Cash Flow Mistakes to Avoid in Your Business
Small businesses usually come up with various activities in the hopes of boosting marketing results. It may work to some extent if the owners apply proper practices. However, it leaves little time for a company to manage its cash flow. Unknowingly, the company’s finances are already taking a downturn.
Even though you are the most brilliant among the team and your company has seen significant sales on the first day, mismanaging cash flow can bring the business down. Studies show that 80% of businesses fail within their first five years of operation.
The worst thing about it? There are hidden costs or expenses which you will have to contend with. These are not easy to manage since you may not easily notice them. In this article, we’ll show some of the typical cash flow mistakes you must avoid. Assess what you might have been doing and set tactics to address them.
1. Forcing Growth
Mr. John recently started an online store selling personalised textiles and apparel. To market his products, he started experimenting with Facebook Ads. In his first month, John gained a substantial return on his investment. He sold thousands of items during that time, generating him a whopping 200 percent sales. Thrilled with Facebook marketing, he increased his Ads’ spending by as much as 20 percent, expecting he would reap 20 times growth in sales.
To Mr. John’s demise, that did not happen. Of course, he was able to generate more leads but not equivalent to the amount he spent. In other words, he spent more than he earned that month. That severely affected his cash flow. To prevent further losses and fund new strategies, he had to take a short-term loan. If he adequately addresses the issue, he could make up for his loss. Otherwise, he’ll have to contend with interests or might as well, end his business for good.
The story of Mr. John reflects a lot of other entrepreneurs. The thrill and excitement of generating whopping sales seem irresistible. But it should not be forced. It must undergo the right processes, integrating all the complementary approaches.
Now, what is forced growth? It’s pushing for practices or activities even though a company is not financially capable. It usually happens if you raise your employee’s salaries, establish a bigger office to accommodate more people, and purchase new sets of products beyond the budget cap. Of course, these are all for better hopes and results.
However, these are effort-oriented tasks that you need to handle rapidly as losing too much cash can impact your daily operations. Extended services may generate additional revenues. However, it can lead to more cash outflows.
That is why it is imperative to efficiently estimate these cash outages so you can identify proper practices. Yes, you can always pursue growth, but make sure your cash flow complements your growth. If not, strategise for ways to make it so.
2. Too Much Spending on Sales
If you are a small business or start up, it’s enticing to attract as many customers as possible. Some would even go to the extent of doing that, regardless if there are losses incurred or not. However, spending on sales must be done with proper techniques to maximise returns and minimise losses.
To determine whether your client is chipping in the profit you estimated, there are two established metrics you can use. The first is the “Acquisition Cost” of the customer, which refers to the amount allocated to gain one customer.
The second metric if the “Lifetime Value” of the customer. This refers to the overall revenue incurred by a customer over its lifespan. Take note, however, that the Lifetime Value should be higher than the acquisition cost. In that way, you can expect positive effects on your business’ cash flow.
On the other hand, your company can only gain a few customers with minimal returns if you overspend on the acquisition cost. A lot of businesses fail to see this point as they commonly believe that the more customers there are, the higher the profit. But it does not always work that way.
That is because various hidden elements revolve around the acquisition cost. For instance, you hired a salesperson to market your product or service. You would have to consider his salary, the amount he spends on mobile and Wi-fi connection, the cost of his seat in the office, his travel allowances, his commissions, etc. You need to identify and consolidate all these indirect costs to come up with sound and detailed calculations.
Otherwise, you will end up burning more money than you earn, eventually, putting your overall cash flow at risk. Spending on sales proves critical in every business, but make sure you consider both hidden and standard costs to minimise leakages, possible overspending, and unnecessary expenses.
3. Miscalculating Profitability
Ms. Gina sells laptop and desktop accessories on the world’s biggest eCommerce sites such as Amazon and Alibaba. She buys the materials at 50% from her sources. Gina buys a keyboard at Rs. 700 and sells it at Rs. 1,100. She used to believe that she was making around 40–50% on every sale, considering the menial expenses.
But when she prepared her balance sheet for the year, she realised that she was incurring losses, lots of accumulated losses. That is because she did not account for the transaction fees, transportation/shipping costs (which differed for every order), platform commission, inventory storage costs, and above all, cost of returns.
Ms. Gina’s case applies to thousands of entrepreneurs, especially those engaged in eCommerce platforms.
A lot of business people believe that they can rake enough profit from every transaction they make. However, Ms. Gina’s experience demonstrates that committing too much on overheads can drive businesses, whether big or small, towards dangerous cash problems.
Some of the biggest companies buy large offices or invest too much in rents, high-end utilities or equipment, luxurious cars, and treat these as trivial expenses at first. But when a company gets into financial trouble, these petty expenses end up as heavy losses. It’s no wonder why we see companies from being cash-rich to cash-hungry in a blink of an eye.
To avoid such cases and ensure the well-being of the company, you should anticipate all these expenses and their consequences. Remember, a company can only be profitable if there is enough money left in the bank after settling all your payments. Higher assets in the paper suggest a better cash flow. That is something you should always maintain in preparation for impending challenges.
4. Forgetting/Ignoring the Seasonal Nature of the Business
This only applies to businesses that do not have a year-long operation. However, it can also affect companies that partially sell seasonal products or services.
Imagine you are selling fresh flowers from the highland farms. Expect to receive bulk orders during special occasions such as Christmas or Valentine’s Day. Surely, you would be busy as you rake in significant sales during these periods. These turn into your cash-rich days or weeks where it is quite challenging to manage cash outflows.
When the cash-rich season commences, it results in overhead commitments. These are difficult to sustain during the off-seasons. Moreover, these off-seasons lead to discounts and offers, thereby decreasing the margins to maintain levels of sales and meeting customers’ demands.
To avoid issues like that, set enough allocations for the off-seasons in your budgeting plan.
5. Neglecting Late Payments or Overdue Invoices
Incurring late receipts against your invoices can ram your business to the ground. Ignoring late payments has led numerous companies into almost or total bankruptcy. The reality is, the more your customer delays payments, the more difficult it is for you to pay your supplier or vendor. If your supplier can no longer wait for your customer’s payments, that leaves you the responsibility to pay him off if you want to sustain a good relationship.
6. Mismanagement of Taxes
Every business is obliged to pay tax. Make sure to pay your taxes before or during the prescribed deadlines. If not, you incur interests and penalties that can severely affect your business’ cash flow. If you commit several defaults and violations, you will attract higher penalties and bigger interests in such penalties.
When preparing your financial plan, make sure to account the obligatory taxes, and set accurate calculations. If you are having a hard time on this, you can always consult a tax expert in determining the estimated amount that you will need to pay for the following year.
7. Neglecting Untoward Events/Incidents
Mr. Tim, a respected real estate investor, laid out a plan for a massive development project on rolling terrain. He called it the real estate project of the century, and it would showcase sophisticated engineering designs such as subways, skyscrapers, and green public spaces. Construction then began, and thousands of engineers, workers, and other skilled personnel took part. Mr. Tim pooled all his billions for that single project, anticipating that his billions would multiply ten-fold.
When the project was 90% complete, the unexpected happened. A massive earthquake jolted the site, causing structures to collapse and putting an end to such an ambitious plan. All the extensive efforts and resources poured for the project came to an unaccountable loss.
Unfortunately, such a story manifests in various other projects, including dams, mines, transportation routes, and housing units. Billions after billions have been lost due to such calamities. Numerous businesses also filed bankruptcy due to such untoward incidents.
Among other common occurrences that can severely impact a company’s cash flow are tsunamis, flooding, volcanic eruptions, and super typhoons.
But that is not only what a company should be preparing for. Internal issues can also create significant losses for the company.
For example, your top performer who has been responsible for putting your company into limelight suddenly decided to leave. Or a customer or another business filed a lawsuit against your company due to product or service complaints. Events like these cannot be anticipated in advance and subsequently, putting a hole in your system and causing cash flows to leak almost instantaneously.
That is why it is imperative to set preparatory strategies from these mishaps. You can never know when and how they will happen. But with a solid plan in place, you can be sure that immediate measures are taken to resolve them. One tactic that you should not forget is to prepare an emergency fund to sustain your business’ daily operations.
It also helps to apply for insurance. Good thing, most of the biggest insurance companies provide services related to calamities and other unforeseen incidents
8. Neglecting Credit Score
Companies usually ignore their credit scores, perceiving them as insignificant. However, accumulating them can turn out big. If they keep piling up, it will set a negative front on your company’s credit history. As a result, it will be more difficult for you to secure a loan when you badly need it.
Don’t underestimate the power of small business loans. Let’s say your company lost a major chunk of your equipment to calamities. You would need to secure a small loan to replace essential tools in your business.
If you have bad credit lenders or investors might see you as a potential risk and therefore, refuse to offer short-term loans. To convince them, you would have to provide a part of your company’s assets as collateral for the loan.
9. Hiring the Wrong Employee/s
Ms. Tina realised that her eCommerce store is ready for scaling. She decided to hire two sales executives to boost the company’s digital marketing campaigns. The two new employees showcased outstanding accomplishments on their resumes; thus, they qualified. They even requested Ms. Tina for a 40% hike in their salaries, and she agreed, anticipating that they could multiply the company’s current sales. She even spent the first month training them and sending them to seminars locally and abroad.
Unfortunately, nothing happened the following month. The company gained no new sales from these two new employees. Ms. Tina thought that perhaps, they are still adjusting and need more time, so she waited for another month. However, they only achieved less than 10% of their sales target. The same case happened in the forthcoming months.
Finally, Ms. Tina decided to let them go.
Now, that’s what happens when you hire the wrong people. You must have spent vast sums of money for them but then ended up seeing their lack of skills or ability to meet your company’s needs. Of course, that will put a deep slash on your cash flows.
This is why it’s important to ensure that your hiring process will select the most capable employee, not just anyone else with lofty-sounding resumes.
As discussed, there are many factors to consider in order to mitigate cash flow leaks in business. Take the time to carefully plan how you can boost your cash flow and lessen your expenses. Get a business line of credit before you need one, or apply for a small business loan when you need to boost your working capital.