03 May Opportunity Costs Of Low Cash Flow
Even if your revenue far exceeds your expenses, your business could still be short on cash. Poor cash flow affects millions of businesses every year, slowing down daily processes and effectively cutting off opportunities for growth. However, negative cash flow doesn’t have to affect your business. By learning how to manage cash flow, you can avoid these issues before they start.
What Causes Poor Cash Flow?
The causes of poor cash flow can vary from business to business and industry to industry. That said, there are some common issues that can exacerbate low cash flow. The number one culprit is poor cash flow management. If you fail to implement the necessary revenue processes to ensure that your business gets paid on time and that money is distributed throughout your business promptly, you will inevitably experience poor cash flow effects like slowed growth and low productivity.
If your business operates within the staffing industry, there is a good chance that you could experience late payments or long payment terms. For example, if your clients have up to three months to pay a bill, you could see huge variations in your cash flow on a day-to-day basis. Similarly, healthcare facilities frequently see late or delayed payments from health insurance providers. So, depending on your industry, you may view cash flow problems as a natural part of doing business — but they do not have to be.
How Negative Cash Flow Affects A Business
Whether you are dealing with negative free cash flow or negative operating cash flow, it could have a devastating effect on your business over the long term. The opportunity costs alone are enough to prevent your business from outpacing your competitors. So, let’s take a closer look at some of the most significant opportunity costs of low cash flow:
Inability To Scale Your Business
In most industries, growth is a necessary element of success. If your business cannot grow, it cannot adequately compete in the open market. Unfortunately, poor or negative cash flow can leave you powerless when growth opportunities arise.
For example, let’s say that your business has one product line that is especially popular. In fact, it is so popular that your business regularly runs out of stock and has to turn away customers. If you have poor cash flow, you do not have the opportunity to purchase additional inventory or hire employees to meet increased consumer demand. Revenue will remain stagnant, which will likely continue the cycle of poor cash flow.
If your business processes could become more efficient through the acquisition of new equipment, you will certainly want to take advantage of the opportunity. However, if you don’t have the cash on hand to pay for it, you may have to wait until your cash flow issues are resolved. In short, poor cash flow is one of the greatest barriers to growth and scalability — regardless of your industry.
Poor Employee Productivity
While you may be focused on your business as a whole, your staff could be hit the hardest by poor cash flow. When there’s not enough cash flow to maintain daily operations, your business may have to delay staff salaries. Not only will delayed salaries negatively affect morale, but they could also greatly reduce productivity.
An unhappy workforce is an unproductive workforce. When staff can’t get paid on time, the initiative to work and give 100% will naturally decline. If your business repeatedly fails to pay workers promptly, you could even see a high turnover rate. Not only will this reduce productivity, but it will also increase your expenses. You will have to continually take the time and money to train new staff, which will likely make your cash flow problems even worse.
Reduced Vendor Credit
If you have a long-standing relationship with a vendor, you will likely have a decent line of credit that you can use to make orders — even when you do not have enough cash on hand. However, to maintain a healthy business relationship and, by extension, a solid line of credit, you will have to make your payments on time.
When vendors see a history of late payments, they pull back their credit. This reduces your ability to take advantage of new growth opportunities as they arise. If you do not have cash or credit, your supply chain could fall apart, and take your revenue with it.
Reduced Profit Margins
Even if you ignore the lost opportunities that low cash flow can cause, it is hard to ignore the effect on profit margins. When you have poor cash flow, your business must find ways to increase revenue as quickly as possible. This often results in the reduction of profit margins to secure more sales.
By reducing profit margins, you are ultimately ensuring less cash for your business in the future. In essence, it is a short-term solution with potentially catastrophic long-term effects. Moreover, the desperation to secure as many sales as possible will put you into a vicious cycle of needing more and more productivity, with less and less to show for it.
Loan Financing Fees
When a business is short on cash, one option is a business loan. However, depending on the size of your business and the terms of the loan, a business loan could end up cutting into your profits. Loan financing fees, including interest payments, can actually make it harder to get out of the low cash flow cycle.
As of 2021, the average business loan interest rate can fall anywhere between 3 to 7 percent. So, if you choose to take out a business loan of $100,000 to pay for your expenses, you could pay as much as $7,000 per year in interest until the loan is repaid. This doesn’t even factor in standard lending fees, which can vary from lender to lender.
How To Manage Your Cash Flow
Managing cash flow issues can seem like an uphill battle. You need to oversee the day-to-day operations of your business, but you also need to calculate your expenses and ensure that enough cash flows in to keep every part of your business up and running. Fortunately, there are a few different ways to increase your working capital:
- Lease equipment or property — While buying equipment or real estate outright will reduce your long-term costs, leasing is a simple way to help increase your cash flow now.
- Evaluate your inventory — If you have some products or services that are not selling as well as others, consider reducing your investment in those products or services to focus on your best sellers instead.
- Improve your billing cycle — If you do not send out invoices on time, you won’t be paid on time; improving your billing cycle can help your business run more smoothly and increase your cash flow.
- Offer early payment discounts — Giving clients an incentive to pay their bills early can help ensure that you have more working capital, though it will take away from your overall revenue.
These cash flow management techniques should help you see increased cash flow over the short term, but they may not completely solve your small business cash flow problems. For this reason, you should consider payroll financing. Unlike traditional business loans, payroll financing can offer you same-day funds that are designated for payroll expenses.