Not all business failures are due to lack of profitability.
Even profitable businesses go broke when they run out of cash.
Cash flow is the ability to generate a sufficient supply of cash so that a business is able to meet its demand for cash and pay it’s debts as they become due.
The main causes of cash flow problems are:
- Losses or low profits:
Low profits or losses inevitably bring cash flow problems. Most loss-making businesses eventually run out of cash.
- Holding too much stock:
Holding too much stock ties up cash and there is an increased risk that stocks become obsolete and can’t be sold.
- Allowing customers too much credit and for too long:
One of the most common causes of cash flow problems is poor credit control i.e. giving too much credit to customers and giving credit for too long.
- Overtrading (growing too fast):
This occurs where a business expands too quickly, putting pressure on short-term finance. Expansion without having the required finance in place will result in a cash crisis.
- Seasonal demand:
Predictable changes in seasonal demand can create cash flow problems if the business has not organised the proper finance for it.
- Over-investment in capacity
This happens when a business spends too much on production capacity or facilities. Equipment which is not being used does not generate revenues – so is often a waste of cash.
Having a proper budget, business and financial plan can ensure your business does not run into cash flow problems.