Common cash flow problems and solutions for small businesses

Published Wednesday 24 April 2024

What is a cash flow problem?

Cash flow is the lifeblood of every business. When you have positive cash flow you can cover all your costs because enough money is flowing into the company to compensate for the outflow.

By contrast, if too much cash is going out of the company without enough coming in you’ll end up with a negative cash flow. This means you have a cash flow problem and your business could become financially vulnerable as a result.

Calculating your cash flow can be particularly important for small businesses. Learning to forecast your cash flow and identify any issues early on can significantly benefit your business and help it thrive.

Common cash flow problems businesses may experience

Let’s look at how to solve common cash flow problems.

1. Slow or irregular payments from customers

Receiving slow or late payments can pose a threat to your cash flow as you’ve already paid to produce your items or services but haven’t been able to recoup your payment yet, leaving a hole in your finances.

It’s also common for businesses to receive irregular payments, instead of having a steady monthly income, which can be tricky to navigate as it disrupts the equilibrium of your cash flow, making your accounting harder to predict and prepare for.

Solution: Better manage late payments through invoice management

To prevent slow or irregular payments from disrupting your cash flow, make sure your payment terms are clear from the outset and use robust follow-up procedures to ensure all repayments are recouped on time. You could even offer early repayment discounts to incentivise customers to pay you quickly.

Xero’s online invoicing software and payment reminder features can help you keep on top of all your customer payments.

2. Insufficient profit margins

You need to be making a solid profit to maintain positive cash flow. The size of your profit margin is, of course, therefore very important.

Making sure your profit margin is large enough is vital to facilitate growth and to ensure your business can sustain itself long-term.

Solution: Look for ways to boost your profit margins

Get started by learning how to calculate your profit margins.

If your profit margins are tight and you need to increase your profit, it’s worth looking at where you might reduce your costs – such as renegotiating your vendor contracts – and taking time to identify and eliminate any waste in the business. You could also assess your value-based pricing strategies to see if there’s room to improve your margins and ultimately ease your cash flow.

3. Lack of cash reserve

When you’re in the throes of running a small business, building up an emergency cash reserve can fall by the wayside. However, effective planning can help your business weather unexpected complications or events – some of which will be completely out of your control. Should the worst happen, a lack of emergency savings can quickly cause issues for your cash flow and leave your business vulnerable.

Solution: Build your financial safety net

Effectively managing your cash flow includes planning for the unexpected, whether that’s unanticipated expenses or market fluctuations. To do this successfully, you’ll need to consider what your specific business needs are and analyse just how risk-tolerant your current business is.

From there you can take steps to future-proof your business, including setting budget goals, allocating funds carefully, and prioritising saving. Not only does getting a handle on your budgeting and spending improve your profit margins and cash flow, but it’ll also enable you to build an emergency cash reserve to act as a financial buffer.

4. Unrealistic growth or poor expansion planning

Rapid growth at first glance seems like a great thing. However, the change it causes could disrupt your business’ health. Rapid growth can come with high costs such as expenses outweighing capital, cash flow and profit being conflated during accounting, and incorrect growth forecasting.

If you’re approaching a growth era, Xero’s financial modelling and planning tools can support better, more informed decision-making.

Solution: Manage growth wisely

If you’re in a fortunate situation where your business is experiencing high growth you may want to slow down to ensure you have a sound financial plan in place. Just like you’d do in regular times, you’ll need to factor in developing a financial safety net and investing in each area of the business at a steady pace.

Taking the time to fully prepare your entire business will allow you to grow more sustainably and responsibly, ultimately creating a well-balanced cash flow. Growing too fast without a solid financial and cash flow plan could mean you spend too much too quickly, leaving you worse off afterwards.

Xero’s budgeting and forecasting guides can help you to efficiently allocate your resources so your business growth doesn’t come at the expense of your cash flow.

5. Inadequate bookkeeping and financial reporting

Inaccurate or disorganised bookkeeping obscures your true cash flow, making it impossible to accurately manage. Getting the fundamentals right is therefore vital for your business’ health, helping you to produce accurate financial reports.

Solution: Embrace accurate bookkeeping

Balancing the books accurately and in an organised manner is crucial for every business. An easy way to improve your bookkeeping practices is to use the latest software, like Xero’s accounting software for small businesses.

Developing clear reporting will improve your cash flow visibility and enhance your decision-making skills.

6. Excessive debt burden

Loans are a useful way for all businesses to get themselves off the ground or to fund growth but it’s key to get the balance right. An over-reliance on debt can negatively impact your cash flow if you can’t afford the financing during tighter months, and high-interest costs could buckle your financial health in the long term.

Solution: Tackle debt strategically

Managing your debt responsibly is key to getting business loans and repayments under control. Take a look at whether you can refinance your loans to find better deals or renegotiate with your lender to see if you’re on the best payment plan you can be.

Don’t let debt repayment slide down your list of priorities, especially in the case of high-interest loans, as it’ll cost you more in the long term. Creating a robust repayment plan with an eye on getting the best deal on the market will free up cash for your other business needs.

7. Inventory management issues

Building up too much inventory ties up your cash in stagnant stock. Not only does this negatively impact your cash flow, as you’re not earning your money back, but it also increases your storage costs if the goods you sell are physical.

Solution: Optimise inventory management

Optimise your inventory levels by accurately forecasting demand and implementing just-in-time inventory instead of building up stock reserves.

You can improve your management practices by using inventory management software to minimise the guess-work, better plan for what you actually need to produce, and prevent your cash from being tied up in slow-moving stock.

8. Unrealistic customer payment terms

If your payment terms are confusing or unrealistic you’re going to run into pitfalls. They will affect your accounting and cash flow because you won’t be recouping what you expect and when, plus they could jeopardise your customer relations and damage your business’ reputation.

Solution: Align expectations and secure payments

Ensuring customer payment terms are clearly communicated and are realistically set can help to avoid confusion and create a harmonious business transaction. Make sure to enforce your payment terms in a polite manner, offer alternative payment solutions if they’re unable to upkeep payments, and be realistic with your pricing and repayment terms.

9. Unexpected expenses and business disruptions

Even the best-managed businesses with the healthiest of cash flows will experience disruption at some point, that’s just life. If you haven’t built contingencies into your business plan to weather unexpected events, then your business could be left vulnerable in tough times.

Solution: Prepare for the unexpected

Every business needs to consider what they’ll do if market conditions change suddenly or if their plans don’t work out as expected. Creating a detailed contingency plan to outline how you’ll deal with turbulent times is important to ensure that if the worst happens you have a plan ready to put into action.

If this happens, you’ll be able to rely on your emergency reserves to keep the core of your business running and to provide your cash flow with flexibility while you tackle the bigger issues you face.

How Xero can help your cash flow

Xero’s accounting software can help with:

1. Faster Payments: streamline your online invoicing with reminders and online payments available straight from your invoice, so you can make it easier for your customers to pay you, to get paid quicker and reduce late payments.
2. Smarter Spending: track expenses, categorise them easily, and identify where you could be saving, to help you budget effectively and forecast more accurately.
3. Clear Visibility: real-time dashboards and cash flow forecasting allow you to see your cash position anytime, and proactively manage your cash flow.
4. Effortless Bookkeeping: our user-friendly interface and automated features will save you time, eliminate manual entry, and allow you to work on the go.

With Xero’s accounting software, you can streamline your business accounting and stay on top of your cash flow. Find more information on cash flow management for small businesses in our cash flow hub.