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Regardless of whether your business is big or small, young or old, successfully managing cash flow remains an often-overlooked key to scaling growth and weathering unpredictable competitive threats and economic cycles. And while the subject matter may not be as captivating as discussions around the latest digital marketing strategies, technology innovations or employee engagement initiatives, avoiding common cash flow pitfalls will help ensure your business is well-positioned for long-term growth.
The following are four common cash flow missteps that can pose a serious threat to your business.
1. Absence of or inadequate cash flow forecasting.
At best, predicting the future is a challenge; and in the wake of the economic turbulence experienced in the last decade, forecasting might seem like a futile effort. However, a well-thought-out cash flow forecast is a critical input when making funding and investment decisions. Investing the time and resources into establishing and/or improving this process can help ensure your business isn’t borrowing more than it needs, leaving funds unnecessarily idle or being forced to tap into overdraft facilities.
Fortunately, the accuracy of your forecasting process is easily measured by comparing past projections with actual results on an ongoing basis. For most businesses, a variance within 10-20 percent is acceptable. If your forecasts are consistently off by margins greater than 20 percent, a deeper dive into the variables creating these large discrepancies will reveal insights that could prove to be invaluable to the long-term health of your business.
2. Being passive about receivables.
Asking clients or customers to pay their bills can be an uncomfortable discussion, but a spike in accounts receivable that isn’t attributed to new business development can be a sign of trouble on the horizon.
Even in times of large cash surpluses, you must guard against being passive about collecting past-due payments. Creating and communicating clear guidelines on payment schedules and consequences for when payments are late along with establishing processes for prompt invoice issuing and tracking will help prevent delinquent payers and maximize cash inflows.
3. Ignoring the risks of customer concentration.
Even businesses that are on sound financial footing will inevitably hit a bump in the road if their largest two or three clients make up 40 percent or more of revenue. The most obvious risk of high customer concentration to cash flow is the unexpected loss of a client, as losing 15 percent or more of revenue can quickly cripple a business.
High customer concentration can also create cash flow problems when large clients use their disproportionate negotiating leverage to extend payment schedules or exert downward pricing pressure that results in tighter margins and cash flows.
In light of these challenges, keeping your largest customers to no more than 10-15 percent of annual revenues will help ensure adequate diversification and alleviate concentration risks.
4. Not building a cash cushion.
No matter how good your forecasting, invoicing and cost controls may be, nearly every business faces unexpected downturns and disruptions at some point in time. Having a cash cushion on hand during these times not only helps you weather the storm, it will enable you to continue to make strategic investments as unique opportunities arise and serves as a safety net should your company introduce new products or expand into new markets.
“For most businesses, a cash reserve and/or unused line of credit availability equal to six months of expenses is enough of a liquidity buffer to avoid running out of operating cash after the loss of a key customer or to absorb a costly mistake such as a failed product launch,” according to Bruce Daniels, SVP, Commercial Banking Team Leader, SVB Private.
As every CFO and business owner will attest, steady, predictable cash flow is the fuel for running a successful, growing business. Despite its importance, study after study has found inadequate cash forecasting and management to be among the leading causes of business failure. By developing and implementing a strategic plan for improving cash flows, companies can optimize working capital, improve profitability and help ensure long-term viability and success.