‘Go with the flow’ isn’t apt advice when it comes to cash management. This liquid asset needs to be monitored and regulated well in order to keep a business afloat (let alone thriving). Cash flow problems occur when a business does not have enough liquid cash to cover its liabilities.
What causes cash flow problems?
‘Go with the flow’ isn’t apt advice when it comes to cash management. This liquid asset needs to be monitored and regulated well in order to keep a business afloat (let alone thriving). Cash flow problems occur when a business does not have enough liquid cash to cover its liabilities. When cash outflows exceed cash inflows, businesses find it difficult to pay debts and cover other expenses.
You might be wondering how many businesses fail due to problems with cash flow. For struggling businesses, the pandemic rubbed salt on this already festering wound — as per a global survey, insufficient cash flow was the biggest problem businesses faced during that time. Over 85% businesses reported the pandemic had a high or medium financial impact on their operations.
Reasons for cash flow problems
1. Losses
What causes cash flow problems to begin with? Right off the bat, loss is the usual suspect for cash flow problems. This seems like common sense as a loss-making business, by definition, has a larger outflow of cash than inflow. Unless the business is viable, its engine starts sputtering over the medium to long term and soon runs out of fuel.
2. Overspending
When a business decides to spend more in the present keeping future profitability in mind, what happens if the move falls through? The reason why cash flow problems arise, particularly in the short term, is when businesses spend too much capital to boost its productive capacity.
For instance, if a company introduces a new production line or expands into new premises, without sales to support these activities, this can create short-term financial issues such as financial overdraft. The company counter-intuitively starts to over-expand or grow too rapidly before demand and sales start to flow in.
3. Excess stock
Managing stock is a delicate balancing act. On one hand, a business needs to hold enough stock to meet demand and benefit from reduced unit cost of each stock item. On the other hand, holding excess stock ties up cash in working capital. Too much of unsold stock holds the risk of becoming obsolete or falling in value.
4. Too much credit
It’s an acceptable norm in many businesses to allow customers to buy goods, products and services on a line of credit. Those who buy on credit are known as trade debtors. Allowing customers to take too much credit and handling customers who take too long to pay back is a common problem in businesses that can lead to cash flow problems.
5. Over-trading
Overtrading happens when a company takes on more business than its resources can support. The key issue here is it places more pressure on the short-term financial resources.
Case in point, imagine a restaurant that wants to start a chain and open new franchises as possible. If they want to open in seven different malls, they’ll have to pay rent in advance, they’ll have to pay the shop fitters to fit the stores out, and of course recruit staff and chefs. Before they know it, they’ve spent a lot with no sales yet. This creates a short-term pressure on cash flow. Similarly, many firms become cash-strapped when they launch too many outlets. When expanding, Businesses must make provisions for over trading as it is one of the most common source of cash flow problems.
6. Unpredictable cash flow
A business that sells umbrellas knows that demand peaks during the monsoons and dissipates in other seasons. If a business deals in seasonal demand, it could also be a reason for cash flow issues. However, it’s easier to manage if they know what is coming. Unmonitored unpredictability, on the other hand, can turn into a big issue.
Conclusion
Reasons outlined here for cash flow problems show that a rule of thumb like, ‘cash rules everything around me’ is true for businesses. That’s why managing cash efficiently is a priority for corporate treasury teams – if it’s not already. In simple terms, cash management is the process of managing cash inflows and outflows. Cash flow management challenges include:
- Volatility of cash flow
- Too many manual processes
- Lack of visibility into cash flows
- Fx/Risk exposure
Read our latest E-book to know how you can unlock cash with new age treasury management or get in touch with Eka experts here.
