A cash flow shortage occurs when there’s not enough cash coming in to cover all of your expenses. Debt service payments - both principal and interest - are part of the amount that you pay out. If they’re too high, you will have a cash flow shortage. And once you are short, the debt only gets harder to carry. A late payment brings late fees, and the fees and interest start to accumulate, making it even harder to catch up. One missed payment can easily snowball into a debt trap if not caught early. If you get behind in payments to the point where your business misses a handful of payments, your credit score will likely take a hit, and it’ll be harder to get approved for additional loans and access your lender’s best advertised rates. When you ask for money, investors and lenders want to know that your business can repay the loan. A business visibly struggling to make ends meet will have little chance of earning additional funds from lenders or investors.
The damage spreads well beyond your lenders. Payroll, health benefits and rent can get put off, hurting morale, production and even the supply chain. Outside, inventory from suppliers, insurance and the subscription software needed to do business will also feel the impact. You can’t budget for emergencies. You can’t invest in what you need to grow. You can’t pay suppliers on time.
So, how do you get cash flow under control when debt is the problem? Start by working out how big the shortage really is. A company can be profitable, with revenues greater than costs, and still face cash flow problems. By reviewing business bank statements over the last six to twelve months and checking average month-end balances, you can see the amount of additional funding required. Compare the average amount you actually have on hand with the amount you need to keep working smoothly and make investments. If the shortage occurs in certain months only, it may be seasonal; you can finance this by saving money during stronger months. If the shortage is regular, a more in-depth examination of income and costs will be needed.
Next, look at your income carefully: when is the money recorded as income and when is it actually in your account? An invoice goes out to the customer and accounts receivable is recorded on your books. On paper the sale is made, but until you actually collect the money, it will not be there when you need to make a payment. To create a cash flow crisis, all you need is a big invoice followed by a slow-paying customer. If customers aren’t paying promptly, consider changing your invoicing policy to encourage timely payments.
Then go through your bank statements for the past year to identify regular payments and those that happen less frequently, like annual insurance premiums and professional licensing fees. If you have business credit cards or credit lines that are paid from your bank account, include their statements, as well. This will give you a good idea of where your cash goes, when it goes, and how often. Figure out how much money you can free up by eliminating, deferring or cutting non-essential expenses. Never cut an expense without weighing its value to the bottom line. If marketing or advertising brings in a large share of your revenue, cutting those might save you money, but it will reduce the money you make.
Your vendors can help as well. Some suppliers may require payment on receipt, but a business can negotiate for up to 30 days, and some suppliers allow up to 90 days. Even a 30-day extension can give you the window you need to get your cash flow straightened out. You can still get merchandise on credit; you just won’t have to pay as soon as you get it. It won’t be easy, but it’s worth a try, and not everyone will say no. Suppliers may give discounts for being a long-time or repeat customer, or for paying in a different way.
When the debt itself is the problem, look at refinancing. A new loan may offer a lower interest rate, which means you will be paying less in interest over the life of the loan; or a longer term, which spreads the cost out over time and reduces the monthly payment. But while refinancing solves one problem, it can make another worse. Make sure to factor the origination fee and any other costs of the new loan before signing. Depending on how much interest and fees are involved, refinancing may be a help in the short run, but more expensive in the long run. Refinancing can be a good idea, but it only solves the problem if it improves your cash flow.
On the other side of the ledger, get your customers to pay you sooner. Offering rewards or discounts to customers for paying early may be the key to getting cash into your accounts. But early payment discounts should not be so large that they eat into net profit. You can also discourage late payments with a small penalty fee. Late fees should comply with state and federal laws, which may limit the amount that can be charged. Charging too much can result in fines and penalties. An incentive for automatic payments makes customers pay on time more consistently, and cuts the risk of them being late. Allow more ways to pay, like credit cards, online payments, peer-to-peer apps and wire transfers so it’s easier for customers to pay you, but be aware of the fees associated with some of these options.
Bringing in more revenue helps too. A temporary promotion can convince customers to spend more than they normally would. While this strategy cannot be sustained over the long run, it can significantly increase revenue in the short term. Train your sales staff to upsell your customers on premium offerings that will better serve their needs. Cross selling products or services that complement your core offering can drive more sales. Volume discounts entice customers to purchase larger quantities. A discount for repeat customers will mean a more steady source of revenue, as can offering a discount to customers who sign a contract for a minimum term.
Borrowing more can bridge a gap, but when debt caused the problem, new debt needs care. As the name suggests, a working capital loan is used to finance day-to-day operations. A short-term working capital loan can fund payroll, inventory, rent and utilities, and you could have it in hand in as little as one business day. On the downside, these loans usually carry higher interest rates than traditional loans and are repaid over a few months to three years. But once the loan is made, monthly payments still have to be made. A small business line of credit is revolving and only charges interest on the amount outstanding. Business credit cards are best for small, recurring purchases, but because the APR is usually over 20 percent, the balance should be paid in full or within a few months. Before you pull the trigger on any card, ask yourself whether you can actually pay the balance on time. Whatever you borrow, know how to manage the debt so it doesn’t cause another cash flow shortage.
Once you’re financially comfortable enough that you can afford to pay down your debt, it’ll help you to have a financial safety net to fall back on. Aim to keep at least six months of operating expenses in a high-yield business savings account to cover any changes in income or expenses.
Don’t let any of this wait. Cash flow issues can quickly cripple a business, reducing growth opportunities, attracting late fees, and lowering credit scores if left unmanaged. Keeping your cash flow shortfalls in check can help you avoid late fees and prevent you from falling behind on payments.
