82% Of Small Businesses Fail Because Of Cash Flow Problems. Here Are 3 Ways To Fix That
Businesses fail every day for a number of reasons.
- There’s no market for the product or service being sold
- Incorrect go-to-market strategy
- The product doesn’t actually work
- Wrong team
- Poor leadership
- Out-competed by another company
- Lack of experience
The list can go on and on…
But according to US Bank, the overwhelming majority of small businesses, 82% to be exact, fail as a result of cash flow issues. That means the business had potentially achieved successful product-market fit, was growing and servicing customers, and then all of a sudden the company ran out of cash. Bills couldn’t be paid. Payroll couldn’t be met. And next thing you know, the business has closed its doors.
I’ve been an entrepreneur for a while now, and I’ve always known cash flow to be a difficult thing to get a handle on. With my first company, we were growing so quickly that we needed to really learn how to forecast our cash projections otherwise we were going to go up in flames. We had certain opportunities in front of us that, while on paper looked amazing for the company, from a cash perspective were actually very risky. And we learned, through a significant amount of trial and error, how to think about making decisions based on the way cash actually moves in and out of the business—not just what you’re capturing in top-line revenue.
After I exited that business, I wanted my next company to be centered around financial projection software because that’s exactly what we needed so badly the first time around. So, with several of the same team members, I launched Place to provide businesses with tools to more accurately gather and assess financial data to drive sales and operational efficiencies.
Since we know cash flow is one of the biggest obstacles businesses face, here are three ways to better manage your cash and ensure you don’t cut your entrepreneurial journey short:
1. Cash and profit are two completely different things. Are you making decisions off the latter or the former?
One of the big mistakes businesses make is they forecast by saying, “We’re going to close 100 customers, which means we’re going to bring in X amount of dollars.”
That’s not how cash flow works though.
Cash flow, or more specifically, “net cash movement” means cash that comes in and goes out of the business every single day, every single week, every single month, and so on. Just because you book $100,000 in revenue in a month doesn’t mean you made $100,000. On paper it might look that way, but you might find that 40% of your customers pay a few days late. Another 20% pay 15 days late. And 10% of your customers typically don’t pay you for at least a month.
Meanwhile, your bills are due.
Employee payroll is due.
Rent, utilities, platform subscriptions, all the tools you use to run your business—those payments are due.
One of the first things I do when looking at cash is ask, “How much cash do we actually have on hand today?” It’s a little bit like managing your own personal checking account. You can see the available balance. You know how much the bank says you have. But then you also have to take into consideration outstanding transactions, upcoming charges, checks pending that haven’t cleared yet, etc. On a personal level, this can be tedious but you can usually maintain a good sense of how you’re doing, and whether you’ll have enough money in your account to pay your next credit card bill, etc.
Now imagine trying to do that with 30, 100, 1,000, 10,000 transactions happening within your business, every month. On the surface, it looks like the business is making money. But it isn’t until you start to dig into the details that you realize, by the end of the month, you haven’t actually collected all the revenue you’re owed—meanwhile it’s time to pay your bills and employees again.
Now, the company is operating in the red.
2. Payment frequency: how badly do you need cash on hand right now?
The second thing businesses can forget is the importance of payment frequency as it relates to the bigger picture.
We see this all the time with SaaS companies, where most want you to pay annually. Well, if you sell a license for $100 a month, and you tell the customer they need to pay annually, they have to give you $1,200 today. The reason is because, from a cash flow standpoint, having cash in the bank account sooner is a better way to go. You’d rather capture all $1,200 now than stretch that $1,200 over 12 months.
Now, that said, there are nuances here.
If you are operating a business that doesn’t typically require large up-front payments, you may be incentivized to give clients and customers a hefty discount if they pay for six months now—as opposed to paying monthly. Or, thinking the other direction, you might actually be in a great cash flow perspective, and decline a client looking for a discount by prepaying. You’d rather them pay monthly, and capture slightly more revenue in the long term.
Not getting into these details, and failing to understand how these decisions impact your business is why so many companies end up failing.
3. How do you pay your employees? What does that cycle look like, and how does that impact your cash flow?
The worst thing you could possibly experience as a business is to not have enough cash on hand to pay your staff.
The moment the company can no longer reliably take care of their employees, you’re in big trouble. So, to avoid ending up here, it’s crucial to understand how and when employees and team members expect to be paid—because remember, money-in doesn’t always arrive on time, but money-out always goes out regardless. You can’t tell your full-time staff, “Sorry, we can’t pay you yet because our clients haven’t paid us yet.”
Second, you need to take into account all the other times cash gets extracted from the company. How do you pay bonuses? How much of an employee’s bonus is actually factored into their overall target earnings for the year? When do those get paid out? Can you motivate your employees more by paying out bonuses sooner rather than, say, at the end of the year?
The best example here would be sales commissions. If you have salespeople out there working hard for what they earn, how often do you pay them? Do you pay them before the client or customer pays the company, or after? And what happens if one month, a salesperson closes 3x more deals than the month prior? Will you be able to pay their sales commission on time?
As soon as you get in the habit of “fronting” cash (sending it out before it’s taken in by the company), you start to really impact the cash flow of the company. In short, you’re now making decisions based on what you “think” is going to happen—as opposed to how much cold-hard-cash you actually have on hand.