Cash flow emergency: How to solve problems your business may face

Healthy cash flow is critical to any business, large or small.

But no matter how carefully you budget, especially in these uncertain times, a cash flow emergency could occur..

It can be surprisingly easy to encounter problems with this essential element of proper financial management.

Your business might be booming with new orders and fresh hires but, ironically, that apparently positive development could lead to problems with the cash flowing through your business.

According to a recent poll by the British Chambers of Commerce, “More businesses continue to report a decrease, rather than an increase, in cash flow, highlighting the precarious state many SMEs [small and medium-sized enterprises] are still in.

“Only one in four (25%) businesses said their cash flow has increased over the last three months, while 30% have seen it decrease.”

In this article, we cover the following:

• What is cash flow and why is it important?
• Why and when do cash flow emergencies occur?
• How to anticipate cash flow emergencies
• Using software and cash flow forecasting
• How to manage and solve cash flow emergencies
• How two businesses tackled their cash flow challenges
• Final thoughts: Focus on incoming and outgoing cash and use forecasting software

What is cash flow and why is it important?

Cash flow is the amount of money that comes into and goes out of your business over a particular period.

As you’d expect, when cash flow is positive, it means more money is arriving in your business bank account or other payment systems than is leaving it.

On the other hand, if your cash flow situation is negative, you’ll find that more money is going out than coming in. Most bank statements show both the inflow and outflow figures for a set period as well as the detailed transactions.

If this goes on for some time, you might find yourself overdrawn and you could struggle to pay your bills.

It can also affect your working capital – the amount of money you have to fund the day-to-day running of your business.

If you’re looking to borrow money or get an overdraft facility, the lender will pay careful attention to how money flows through your business.

If you cash flow isn’t in a healthy place, they may refuse to lend to you or will only do so at a higher rate or by demanding greater security guarantees.

In most businesses, there are three types of cash flow:

• Operating comes from your everyday business activities
• Investing comes from the return on investments and savings accounts that your business might have.
• Financing reflects how money moves between lenders, shareholders, investors, owners and others.

It’s important to differentiate this from profit, which is usually defined as the balance that’s left in your business’s bank account when all of your expenses are subtracted from your income.

Liquidity is relevant here.

It indicates how easily you can cover your short-term financial obligations.

In other words, although you might have some valuable assets and plenty of profitable orders on your books, you don’t have enough cash readily available enough to pay for things such as staff wages, utilities and, if your business is VAT registered, your quarterly VAT bill.

Why and when do cash flow emergencies occur?

Essentially, cash flow emergencies happen when, for whatever reason, you find yourself paying out larger amounts of money than usual.

More importantly, these big sums are more than you’re taking in.

This might be because you’ve had to invest in new equipment or machinery, or you’ve suddenly got a big order to fulfil and you’re having to purchase larger than normal amounts of raw materials or products and perhaps taking on more staff to fulfil this order.

Maybe you’re heading for a period of the year such as Christmas or the summer holiday season when you’re particularly busy and you’re taking on large amounts of inventory and casual staff.

More generally, simply buying too much inventory and having it waiting in your stockroom or warehouse can have a detrimental effect on your liquidity as well.

You might also find that, in these difficult economic times, a big customer takes longer to pay than usual or even goes under.

Funds might arrive eventually but until they do, you could find yourself struggling to make ends meet.

How to anticipate cash flow emergencies

“Spotting these problems before they hit you is essential,” says Mike Benson, who has run a number of businesses, mainly in the hospitality industry.

“Trying to fire fight when you suddenly realise that you’re running out of cash is no way to run a business.”

It’s important to be aware of these risks and to be constantly on the lookout for warning signs, he says.

Regularly checking your bank balance and chasing up outstanding invoices is essential.

But cash flow forecasting is vital as well.

By taking the time to create a forecast and project what your cash flow will look like over a certain period of time, you’ll have a good idea of what might happen to your cash position if certain events take place and you can anticipate any problems that might emerge over the coming weeks and months.

You can use a cash flow forecast template within a spreadsheet to estimate the amount of money that will come in and out of your business, usually on a month-by-month basis.

Using software and cash flow forecasting

Alternatively, accounting software can help here too.

It can be used to model what might happen to your liquidity if certain scenarios emerge, providing you with forecasts and projections.

You might want to know what impact buying a new piece of kit will have on your cash position or what could happen to the business if you take on another member of staff to fulfil new orders.

You can also use the software to see the effect of interest rate changes and ups and downs with your trading.

Software can alert you if a big customer has changed their payment terms, and it can warn you that a worrying number of customers have outstanding invoices.

This means you can anticipate that your cash flow might be adversely affected until they pay.

Similarly, it can provide the information and the projections you need to plan your finances when you’re investing in new machinery or buying extra inventory.

How to manage and solve cash flow emergencies

Encourage faster payment from customers

Encouraging customers to pay more quickly can help with the flow of cash through your account.

This might include offering discounts for faster or automatic payments.

An equally powerful incentive can be warning about interest charges on late payments, although you’ll need to be careful here not to appear to be too heavy handed, of course.

You could provide a volume discount to encourage customers to place larger orders.

This can bring in funds more quickly rather than waiting for a larger number of smaller orders to come in over a longer period of time. It also allows your customers to save money in the long run.

Increase payment options

You might also want to consider increasing the number of payment options such as credit card facilities, and (P2P) payment methods such as GoCardless, PayPal, Venmo and Wise.

There’s also the option of getting customers to pay using direct debit.

Review your outgoings

If you’re planning to invest in new equipment or you need to buy a large amount of stock, can you balance this by asking a supplier for help with payment terms on this occasion?

It might be that you can pay half of an invoice now and the other half in a couple of months.

Obviously, this should be regarded as a temporary measure.

Putting off paying bills too often and for too long can seriously damage your company’s credit rating and its general financial health.

Make contact early

“The great thing about forecasting and keeping on top of your cashflow projections is that you can spot problems from a way off and you’ve got time to take action,” points out Mike Benson.

“Most people want to help you. Banks don’t want to have a client go under and your suppliers and customers want to keep trading with you and so they’ll very often cut you some slack if necessary.

“The trick is to contact them early, offer them a reasonable deal and keep in contact to reassure them that this is only temporary.”

Review business loans

You should look at any outstanding business loans you have to see if you can get a better interest rate.

In certain circumstances, a short-term loan can help bridge the gap between paying for a new piece of equipment or a large amount of stock and seeing the additional cash that it will ideally generate hitting your bank account.

Review payment terms and look at other financing options

As well reviewing payment terms with your customers, you can do it with suppliers as well. There might well be better terms available if you’re making a major purchase.

Can you pay over a number of months or get financing to help spread the cost?

Invoice financing, where you sell your outstanding invoices to a third party or use them as security for loans can also help.

How two businesses tackled their cash flow challenges

As he was developing Wealth of Geeks, a rapidly growing personal finance and pop culture website, Michael Dinich experienced what he describes as “intensive growing pains”.

Web traffic was “exploding” month after month, he says, but alongside that were major costs for infrastructure, hiring, and content creation.

“Looking back, there are a few steps that really helped turn things around during that crunch time,” says Michael, who is also a financial adviser and a personal finance expert.

“Invoice financing saved our bacon.

“Getting advanced funds from outstanding invoices gave our suppliers confidence and allowed us to cover payroll. To diversify revenue, we consulted on projects and created new revenue streams like our podcast network.

“Cutting costs creatively, like negotiating better vendor rates, helped. Most of all, having open conversations with my team kept stress levels reasonable during the uncertainty.”

Simon Bacher is CEO and co-founder of Ling, a successful language learning ‘edtech’ startup with over five million downloads.

He says: “Ling, like many startups, faced cash flow challenges, particularly in our early growth stages,

“These challenges stemmed mainly from scaling operations, managing large orders, and timing discrepancies in receivables and payables.”

Ling has significantly improved its financial management strategies over time.

Simon says: “By identifying the root causes of these challenges, we implemented solutions such as restructuring operations for efficiency, negotiating better terms with suppliers, and leveraging invoice financing when needed.

“Implementing robust cash flow forecasting is essential to anticipate and prepare for future shortfalls, ensuring ongoing financial stability through strategic reviews and adjustments.”

Final thoughts: Focus on incoming and outgoing cash and use forecasting software

Cash flow problems hit many businesses, especially SMEs, as they grow.

In these uncertain times they’re even more likely to occur.

The trick is to keep laser focused on incoming and outgoing cash and above all to use forecasting solutions so you can identify any difficulties before they happen.

This means you’re ready to manage them with a range of financial and commercial tools should these problems arise.