The Smith’s shop had been profitable from the day they bought it. The shop had run smoothly and there was always money in the bank. Business had progressed so well they decided to move into a larger shop not far away in the same suburb. After the move revenue dropped and cash flow slowed. The business never returned to the same level of success. For the first time in five years they used a bank overdraft and sought a loan from the bank. The business was still making a profit but was struggling with no cash. What went wrong?
The major reason for small business failure is the lack of cash. The lack of cash is a symptom that results from underlying causes. For a business to be successful we need to discover and address the underlying causes for the poor cash flow. Trying to fix poor cash flow without diagnosing the cause is the same as the doctor trying to treat a skin rash without knowing the cause of the skin rash. The treatment will not be very effective if it doesn’t address the real reason for the skin rash. Similarly, there are many possible reasons for poor cash flow and usually there is more than one reason that is affecting our business. Before treating poor cash flow problems in our business we need to diagnose the causes so we can use our resources wisely and effectively.
The causes of poor cash flow can be either external or internal factors. The external factors are those that occur outside of the business and its control. While we may not be able to control external factors we can prepare and reduce the risk and impact of them on our business. Internal factors are those that are within the control of our business. I have outlined below both possible external and internal factors that can affect cash flow.
1. Political – The influence on business by government. For example, the government increased the taxes on certain products overnight without warning causing a fall in sales not only of those products but also of other products in the store.
2. Economic – The influence of the economy as a whole on the business. For example, a rise in interest rates would always cause a decrease in sales of certain products.
3. Social – The influence of demographic composition and social norms. For example, the move to a different shopping centre saw a change in the type of customer even though they were in the same suburb.
4. Technological – The influence of progress in technology. For example, the internet enabled previous customers to purchase from overseas the same product at a cheaper price.
5. Competitors – The influence that competitors behaviour has on the business. For example, the large department stores started to stock the same items as the shop.
1. Profitable – For a sustainable positive cash flow a business needs to be profitable.
2. Debtors, stock and creditors – Poor control of these three factors can cause major cash flow problems. They are the silent killers of cash flow. For example, when the shop moved into the larger premises the amount of stock doubled, this stock had been financed from the cash in the bank.
3. Over capitalised – The purchase of assets that are not producing a reasonable return on investment will affect cash flow. For example, the new shop required new fixtures and fittings however there was no increase in revenue from this investment.
4. Too high borrowings – The business has borrowed too much and its loan repayments are causing cash flow problems.
5. Taxation – The business can encounter problems when it doesn’t set aside money for income tax. Another problem is spending GST or VAT collected before remitting it to the tax department.
6. Owners Drawings – The owners of the business withdraw more cash out of the business than the business is generating.
7. Unplanned or uncontrolled growth – This can be one of the biggest causes of cash flow problems in small business. It results in overtrading, i.e. buying and selling more than the resources of the business can handle.
8. Lack of planning – Cash flow is all about timing. If a business is not prepared for large payments it will affect the cash flow.
9. Poor quality financial information – The lack of regular financial reports will cause poor decisions to be made.
10. Poor internal controls – Internal controls are procedures to safeguard the business’s assets. For example, no procedure to follow up overdue customers.