Businesses always go through ebbs and flows. They can experience months that are incredibly profitable and other months that aren’t. They also have to weather the storm from unforeseen circumstances like the pandemic, recessions, environmental disasters, and more.
This can translate into some serious challenges, like unexpected expenses, trying to keep employees, managing supply chain disruptions, not having an emergency budget, all the while not knowing enough about cash flow management.
That’s why it’s important for small business owners, who have less cash reserves than big enterprises, to be knowledgeable about their finances, so they can put an action plan in place and be prepared no matter what comes their way.
Below, we look at what negative cash flow is and strategies to manage it.
What is negative cash flow?
Let’s first start with what cash flow is in general. Cash flow alludes to the flow of money coming and leaving your business. Cash flow is different from sales or profit. When a business has a positive cash flow, this refers to the fact that more cash is coming in than going out.
Negative cash flow refers to the fact when more cash leaves the business than there is cash coming in. A concrete example would be when a business collects £4,000 in revenue but spends £5,000 on outgoing expenses in a month. When your business is cash flow negative it makes it difficult to get approved for a business loan, cover business expenses, and plan for future growth.
It should be noted that negative cash flow usually occurs for businesses that are just starting out, since there’s a lot of startup costs, and it takes a lot of hard work to start seeing positive cash flow.
In fact, a recent report by Xero found that the average small business in the UK has more than four months throughout the year of cash flow crunches (revenue is less than monthly expenses).
If you are a new business owner, don’t feel bad for having a negative cash flow situation; it’s inevitable. It becomes problematic when you have long-term negative cash flow, because it’s unsustainable, risky, and unprofitable.
What causes negative cash flow?
If you’re currently cash flow negative, it’s worthwhile to understand why you’re in that position.
Here are some common reasons why businesses have poor cash flow:
Low profits: business owners always need to keep profits top of mind. After all, it’s how you keep your business running. Low profits could be for numerous reasons, such as undercharging for your products or services, not enough clients, or costly overhead expenses.
Uncontrolled investing: when you’re first starting out, it can be tempting to invest in a lot. This means spending a lavish amount of cash on services or products that just aren’t necessary. Such spending is known as negative cash flow investments.
Sudden or unplanned growth: ultimately, you want your business to grow. You just don’t want it to grow too quickly and too soon, however, because this could put your business at risk and lead to haphazard hiring, mismanaged financial reporting, and losing sight of your vision. Business growth should be planned and strategic.
Late payments: as a small business owner, you only have so much time and energy throughout the day. You don’t want to be spending it on chasing down clients who haven’t paid your invoice. That’s why it’s crucial to set and enforce detailed payment terms.
Better yet, invest in accounting software that will automatically remind customers about their unpaid invoice.
Poor financial planning: you will quickly experience poor cash flow if you don’t properly plan. That means evaluating your cash flow statements, creating cash flow forecasts, and developing a realistic budget.
How to manage negative cash flow
Having a healthy cash flow won’t happen overnight, but when you implement these strategies, you can get back on track.
Conduct a cash flow analysis
In order to understand your current cash position you’ll need to review a statement of cash flow. A cash flow statement indicates where there are issues with cash flow, such as unnecessary cash outflows, and when you’re experiencing cash shortages. Operations, investing, and financing make up a cash flow statement.
Operations contains the accounts receivable, accounts payable, and income taxes. Purchases and sales of long-term investments like buildings, or equipment, fall under investing. Debt and equity are involved in the financing section. It also includes the sale of stocks and bonds and cash from a loan or even used to pay down debt.
An income statement and a balance sheet are also crucial to review your business’s financial performance. An income statement shows revenues and expenses and where business owners can decrease costs, or increase revenues, to become more profitable.
In contrast, a balance sheet displays a business’s current assets, liabilities, and shareholder equity. Stated another way, it shows what a business owns and owes, along with the amounts shareholders have invested.
Having a clear idea of where your business is heading is also important, which is where cash flow forecasts come in. Forecasts help to estimate business income and operating expenses, usually on a monthly basis. This provides a better understanding of which future financing activities and expenses you can afford and prioritize.
Spend and invest wisely
Before you spend money on new equipment, lease a new office space, hire employees, or spend money on unnecessary expenses, it’s important to evaluate your business’s current cash position.
See where you can make changes and slash spending on investing activities for your business. On top of seeing where you can save, such as working from home instead of renting an expensive space, create a list of items/services you need versus the ones that you would simply like to have. When your business has healthy cash flow, that’s when you can start purchasing your “would like” to have.
Create an emergency budget
Just as it’s good practice to have emergency funds for your personal finances, it’s also good practice to have sufficient money set aside for your business. Whether it’s an unexpected event or unexpected expenses that pop up, you want to have sufficient cash reserves just in case. If you’re experiencing cash flow issues, see where you can cut unnecessary outflows of cash, such as opting for software that’s less costly and allocate some funds to an emergency budget.
Take charge of your cash flow
We understand that owning a business can be cumbersome since there’s so many moving parts. If you have negative cash flow it’s not too late to take charge and move things in the right direction. You can do so by spending and investing cautiously, conducting regular cash flow analyses, and putting cash aside for an emergency fund.
Level up your cash flow with an accountant
If you’re feeling overwhelmed and unsure of your next steps, get the help you need. Whether it’s to assess your current cash balance, or advise you on next steps, start by requesting a consultation right here from one of our London Accountants. Having the right support in place will help your business thrive.