In the United States (US), most small and midsize enterprises (SMEs) fail within the first five years. Specifically, the latest statistics show that more than 20% immediately fail in the first year.
A recent study by a US bank drilled down into the factors that cause this widespread business failure among SMEs. They found that “poor understanding and management of their cash flow” greatly contributed to their failure by 82%.
This article aims to enlighten SMEs about cash flow shortfall and help their businesses thrive. Below are a few simple yet effective ways to reverse a cash flow problem.
Categorize Spending
The first step is determining all expenses and knowing where they’re going. Once all are identified, categorize them into general and administrative (G&A), research and development (R&D), sales and marketing, operations, and cost of goods sold (COGS).
This categorization may be basic, but it plays a key role in planning and organizing a budget. After categorizing, note the percentage spent for every category, then analyze whether the cash distribution is reasonable. If not, take proactive measures.
Benchmark
Learn how other businesses are spending and benchmark their methods to spend similarly. Benchmarking from other organizations helps SMEs understand the competitive landscape and identify areas where they can increase efficiencies, streamline internal operations, reduce costs, and generate new methods.
However, only follow other companies within your industry and your company’s lifecycle stage. One thing to avoid the most is spending more than the available funds. Hence, regardless of benchmarks from other businesses, adjust accordingly based on cash on hand.
Micromanage Expenses
While it’s true that it takes money to make money, not all spending is created equal. Believing this has caused many SMEs to succumb to gross overspending, especially during their first few months of business.
Note that each expense detracts a company from its profit margin. Hence, it’s crucial to always determine and factor in the cost-benefit of every expense, particularly during the early stages.
The cost-benefit analysis comes with a lot of advantages. These include discovering hidden costs, enabling data-driven decision-making, simplifying many business decisions, and developing a competitive advantage.
Forecast
Forecasting is predicting future outcomes based on historical data and management insight. It’s essentially a decision-making tool SMEs can use to budget, plan, and estimate future growth.
It helps SMEs take out the guesswork and put them on a path of strategic advancement. It also enables them to grow as quickly as possible, most sustainably and effectively. That’s why it’s no less important when it comes to cash flow.
Seek Financing In Advance
Any cash flow shortfall can be prevented if SMEs have enough funds. Hence, seeking financing in advance helps a lot. The ideal time to do it is during the initial production stages when your figures are still good. It may lower the risk of rejection later.
Know that most lenders typically hesitate to fund ventures without proof of track record and lack market validation. For them, these companies with no history of success and revenue are risky borrowers, and SMEs are the best examples of them.
Thankfully, there are now alternative financing available for SMEs these days. It includes online loans, personal micro loans, crowdsourcing, and government grants. Ensure to explore all of them to secure the most suitable financing for your business needs.
Borrowing twice the amount you need is also recommended as its capital costs will be much lower. For example, taking a big loan at 10% or less is much more affordable than making several small purchases with a credit card at a 20-30% interest rate.
Encourage Early Payments
Besides seeking financing, one way to boost cash flow is by motivating customers to pay earlier. For example, offer them an early payment discount within a limited time if they pay in full. Consider it a small sacrifice to get access to urgently needed funds. It’s also a great way to strengthen customer relationships.
Limit Inventory
Regulating inventory is another way to prevent and even survive cash flow shortfall. Too much idle inventory typically results in product obsolescence, which leads to increased costs and reduced profits—a good example of negative cash flow.
Regulate inventory to lower costs and improve revenue. Limit items that aren’t profitable and invest more in those in demand. Always closely monitor daily sales activity to predict future sales more accurately.
Final Thoughts
Cash flow shortfall poses a risk in SMEs, but it’s not always negative. For example, at early stages, with all the costs needed to achieve a viable business and initial customer outreach, startups are bound to have more expenses than returns.
Even in a business expansion, mature companies are likely to have more outgoings due to expansion costs, causing periods of negative cash flow. As long as their cash flows trend back to positive, these shortfalls are inevitable and can be considered good signs of business growth.
