The 5 main causes of cash flow problems

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Anywhere in the world, whether you are in Australia, UK, US, Canada, or elsewhere, the causes
of cash flow problems are the same!

CASH IS KING

The ability to generate positive cash flow year in year out is essential for a business to
be viable in the long term.

Surplus cash flow lubricates growth of a business.

It is impossible to successfully grow a business unless it is both profitable AND

generates surplus cash flow on a sustainable basis.

Without strong, positive cash flow a business will never thrive and grow.

Inadequate cash flow is a symptom of management problems in a business, NOT the

cause.

Evidence of Cash Flow Problems

Late payment or non payment of supplier invoices, direct debits being dishonoured,
late payment of taxes and employee superannuation, even worse being late payment of
wages to staff.

More extreme evidence of cash flow problems is legal action against your company by
suppliers or the tax office.

If these problems sound familiar to you and your business, it is time for you to take
immediate action to address your cash flow problems.

You are stressed and it is affecting your family as well.

In this article, we take a look at the 5 main causes of cash flow problems in a business.

Knowing these dangers will help you develop effective cash flow management and maintain a
healthy business cash flow.
Cause 1 - Declining Sales and/or Declining Gross Profit Margins

a) Declining Sales

Declining sales have a devastating effect on your cash flow as a relatively small decline
can cause a massive reduction in your profitability.

This typically occurs when economic conditions deteriorate, there is an increase in

competition from global competitors, new competitors enter your market, or your
industry declines.

As sales decline your overheads will probably remain unchanged so net profit decreases
rapidly.

A detailed table in the addendum at the end of this article vividly demonstrates the
devastating effect of declining sales.

b) Declining Gross Profit Margins

Declining gross profit margins have a devastating effect on your cash flow as a
relatively small decline can cause a massive reduction in your profitability.

Typically occurs when there is pressure on sales.

A detailed table in the addendum at the end of this article vividly demonstrates the
devastating effect of declining gross profit margins.

Cause 2 - Your Business Is Unprofitable

Simply put, you are spending more than you are charging to provide your customers
with goods or services. For example for every $1,000 or 1,000 you charge your
customer you are spending $1,050 or 1,050! That is for every $1,000,000 or 1,000,000
you earn you are spending $1,050,000 or 1,050,000!

Inevitably your losses will accumulate to the point of having to borrow more money
just to stay in business. But eventually you will come to the point where it is neither wise
nor possible to borrow more money and you will have to sell your business, close it
down, liquidate it, or someone else will liquidate it for you, for example the tax office.
 A much better solution is to take immediate action to restructure your business to
generate strong and sustainable profits, this will probably require a very experienced
business turnaround specialist to guide you through this process.

Main causes of lack of profitability include:

A flawed business model.

An underperforming business, either your sales & marketing and/or operations are not
working like clockwork.

Lack of understanding of financial statements.

Lack of accurate and timely financial statements.

Lack of KPI's (Key Performance Indicators) and strict monitoring of them

Low gross profit margins due to high direct costs and/or not charging enough for your
products/services and/or extreme competitive industry pressures.

Poor performance and lack of productivity of staff.

Poor processes, many errors/defects.

Poor stock purchasing and management.

Excessive overheads.

Excessive interest and/or vehicle and equipment finance commitments.

Poor credit approval of customers and poor debtor collection management practices
resulting in high bad debts experience.

Undisciplined spending.

Cause 3 - You Have a Natural Negative Cash Flow Business Model

Examples include:

1. You sell on credit terms, 30, 60, or even 90 day terms, but you have to pay your payroll,
rent, overheads weeks if not months before you are paid by your customers. And your
 payment terms with your suppliers are shorter than the payment terms you have given
your customers.

2. You carry imported stock which you have paid for weeks or months before it lands in
your warehouse.

3. You are paid by way of progress claims for which you also provide credit so you
receive payment long after you have paid your direct factory expenses or subcontractors
and materials expenses. Furthermore, retention payments are withheld by your head
contractors or by your customer.

There are ways to address every one of these circumstances which involve redesigning your
business model and also using appropriate means of financing, most of which are still available,
even if you are already in financial distress.

Cause 4 - Excessive Debt and Capital Expenditure and/or Excessive Personal

Drawings/Benefits

High repayments due to excessive debt and/or repayment of loans over too short a
period. This especially applies to vehicle and equipment loans and lease repayments
which are typically structured over relatively short terms with low or nil balloon or
residual values.

Capital expenditure funded out of cash flow instead of being financed over the useful
life of the asset which puts pressure on cash flow.

Funding purchase of personal property assets or the repayments on these properties

far beyond the capacity of your business to sustain these payments as well as meeting the
ongoing payment of all business expenses within normal trading terms including taxes
and superannuation.

Excessive living and lifestyle expenses.

Cause 5 - Poor Stock or Poor Credit and Debtor Management

Poor stock management, such as carrying stock that doesn't sell through, carrying
excessive levels of stock, not clearing discontinued or obsolete stock, poor demand
planning, undisciplined purchasing habits, or a poor stock management system to name a
few.
 Poor credit management, that is no or poor credit approval processes before providing
customers with credit which will sooner or later result in bad debt write offs and in the
worst cases will result in failure of the business.

Poor debtor management which includes lack of disciplined collection of debts due by
customers, allowing continued credit when customers have not paid their bills within
company credit terms, and lack of regular reconciling of debtors accounts.

Some Final Words

Disciplined cash flow forecasting and management is critical to your business.

If you are experiencing some of the above issues in your business you need to address
them urgently. Unless you can address these problems immediately you may be wise to
engage the services of a very experienced business turnaround specialist to help you
effectively plan and manage your cash flow and deal with the root causes of your cash
flow problems.

Addendum

a) Detailed Analysis of Impact of Declining Sales

In the table below, sales are progressively reduced dramatically reducing net profit
margin.

Note that all figures are presented as cents in the dollar/pence in the pound. Therefore, by
way of explanation for normal sales column:

Sales = 100 cents/pence

Cost of Sales = 65 cents/pence
Gross Profit = 35 cents/pence
Overheads = 30 cents/pence
Net Profit = 5 cents/pence
Fall In Net Profit = Nil
Assumptions Normal Sales Sales Down 5% Sales Down 10% Sales Down 20%
COS=65% COS=65% COS=65% COS=65%
GP=35% GP=35% GP=35% GP=35%
Overheads=30 Overheads=30 Overheads=30 Overheads=30
cents/pence cents/pence cents/pence cents/pence
Sales 100 95 90 80
Cost of Sales 65 62 59 52
 Assumptions Normal Sales Sales Down 5% Sales Down 10% Sales Down 20%
Gross Profit 35 33 32 28
Less Expenses 30 30 30 30
Net Profit 5 3 1.5 -2
Fall in Net Profit cf
Normal Net Nil 35% 70% 140%
Profit(%)

Analysis of this table shows:

5% drop in sales at constant gross profit reduces net profit by 35% from 5 cents in
dollar/pence in the pound to 3 cents in the dollar/pence in the pound.

10% drop in sales at constant gross profit reduces net profit by 70% from 5 cents in
dollar/pence in the pound to 1.5 cents in the dollar/pence in the pound.

20% drop in sales at constant gross profit reduces net profit by 140% from 5 cents in
dollar/pence in the pound to minus 2 cents in the dollar/pence in the pound.

b) Detailed Analysis of Impact of Declining Gross Profit Margins

In the table below, gross profit margin is progressively reduced as sales decline,
drastically reducing net profit margin.
 Assumptions Normal Sales Sales Down 5% Sales Down 10% Sales Down 20%
Normal GP GP Down 2.5% GP Down 5% GP Down 7.5%
COS=65% COS=67.5% COS=70% COS=72.5%
GP=35% GP=32.5% GP=30% GP=27.5%
Overheads=30 Overheads=30 Overheads=30 Overheads=30
cents/pence cents/pence cents/pence cents/pence
Sales 100 95 90 80
Cost of Sales 65 64 63 58
Gross Profit 35 31 27 22
Less Expenses 30 30 30 30
Net Profit 5 1 -3 -8
Fall in Net Profit cf
Normal Net Nil 83% 160% 260%
Profit(%)

Analysis of this table shows:

5% drop in sales and 2.5% drop in gross profit reduces net profit by 83% from 5 cents
in dollar/pence in the pound to 1 cent in the dollar/penny in the pound.

10% drop in sales and 5% drop in gross profit reduces net profit by 160% from 5
cents in dollar/pence in the pound to minus 3 cents in the dollar/pence in the pound.
 20% drop in sales and 7.5% drop in gross profit reduces net profit by 260% from 5
cents in dollar/pence in the pound to minus 8 cents in the dollar/pence in the pound.

Whether you are in Australia, UK, US, Canada, or elsewhere, if you found this article helpful,
why not get in touch.