The Worst Case Scenario in a Negative Cash Flow
The term negative cash flow is one that you usually hear and probably not always in a positive tone. At best, it can have you pulling from your cash reserves to satisfy your debts and cover expenses. At worst, it can put you out of business.
Statistics show that over 60% of small businesses in Australia go under within the first three years, with negative cash flow being the primary reason. In this situation, a business spends more money than it generates in a particular period.
How to Fix Negative Cash Flow
Negative cash flow is very much part of every business. It is a prevalent case for startup businesses investing money to fuel growth, attract customers, and set up distribution channels.
Analytics and financial modelling agencies suggest that It can be a temporary situation that may arise due to the following reasons:
- New competitor entry
- New equipment
- Cash flow crunch due to natural disasters
- Business expansion/acquisition
- Research and development
Sure, growth opportunities can result in a temporary cash crunch. But, if the negative cash flow is decreasing on a regular basis, it should suggest that the business is recovering well and the long-term strategic growth remains intact.
However, if it’s otherwise, then other external factors may be at play.
- Your business is not generating high profits, which is possible due to ineffective marketing strategies, low productivity, low product pricing, poor ordering and delivery process, or uncontrolled spending.
- You are over-investing—spending money on non-critical items. Besides draining your funds, it can potentially leave you with insufficient money to pay for the items that actually matter.
- You are expanding too fast. While expansion plans are necessary to grow and evolve, it should be done with a concrete plan. Otherwise, you risk running out of funds to operate until you earn enough revenue to sustain your daily activities.
- You have high overhead expenses—rent, utility bills, sales and marketing, and other administrative costs. Once these expenses go out of hand, you might eventually see yourself running out of cash.
- Your customers are not settling their bills on time, which not only creates an unhealthy cash flow but also affects your finances and ability to cover the overhead expenses.
- You spend money on unexpected expenses or the things that you didn’t include in your cash flow forecast. This would have allowed you to allocate money to pay for them.
- You withdraw or borrow more money than you can afford to repay. While this may keep you from running out of funds in the short-term, keep in mind that it only delays a looming financial crisis if you don’t address it.
All these factors could be the consequence of your poor financial planning—failure to perform a good cash flow forecast and set a realistic budget. One second you’re suffering from cash shortages and the next, you’re in serious financial difficulty. Unless you resolve it, you will start to go downhill.
Below are just a few of the circumstances you’ll experience with a negative cash flow.
- Cash Crunch – In turn, this may lead to a delay in payments to your suppliers and vendors as well as the salaries of your employees. In worse situations, it can result in poor vendor services, even termination of contracts, and higher employee turnover rate.
- Higher Interest Rates – While debt funding resolves your negative cash flow problem, it comes with a cost in the form of interests that you have to pay back. This can put constraints on your profitability in the long term.
- Business Shut Down – We have already mentioned this early on in the article: if all the possible solutions have been exhausted and you still don’t have enough to cover your expenses, you will lose more money, which may eventually force you to shut the business down.
Unless you experience negative cash flow across multiple quarters, you have nothing to worry. It’s very much part of a business where you have to sometimes spend more to grow.
However, keep in mind to exercise caution as it can also be a case of a flawed business plan. You can work with analytics agencies to help you manage your financial statements. They provide a host of data services and solutions that can help you arrive at a smarter decision.
What do you think is the worst thing that can happen with negative cash flow? Let us know by leaving a comment!