Why Profitable Businesses Go Bust

Apr 01 2020

At the risk of stating the obvious, cash is the lifeblood of any business.  A business that has access to sufficient cash can survive making a loss, but a profitable business that runs out of cash when it needs to pay its creditors will have to cease trading.  Too many managers remain focused on generating profit, without stopping to consider the cash requirements of a business, believing that if they have profit, then surely they must be generating cash.

There are several reasons why cash might not be immediately available if profits are being earned. 

Here are some of main causes:

Tying Cash Up in Illiquid Assets

There are several ways businesses can tie their cash up within the business.  Poor credit control can mean that your customers are using you to improve the cash flow of their businesses.  There are several steps a business owner can take to guard against this:

  • Have a documented credit control process that’s referred to in your sales agreements and stick to it
  • Make sure invoices are sent out as quickly as possible – customers won’t generally even consider when they’re going to pay until they receive and process an invoice
  • Consider using an outsourced credit controller if your business isn’t big enough to employ someone full-time
  • Possibly consider factoring some or all of your invoices (this is where you sell receivables to a specialist finance business that will advance you money and go on to collect the debt)

Carrying high levels of stock or inventory can also tie up large levels of cash. To guard against this, try wherever possible to order in items just ahead of when they are needed so the purchase and sale take place very closely.  This isn’t always possible, so take time to try and identify which items need to always be on hand and only order in other items when they are needed.  Also, consider changing suppliers if your current provider will only accept large minimum orders.  Having lower levels of stock also means you should be able to save money on warehousing costs.

Buying assets and buildings rather than leasing or renting them will also tie up cash, and so you might want to consider entering sale and leaseback agreements to deal with existing owned assets and talking to leasing companies to get a sense of what deals might be available to finance future capital expenditures.  It is also worth considering if it makes more sense to hire equipment that you don’t use all the time rather than buying it.

It might also be worth considering whether you need full-time employees or if you can get by using part-time and flexible workers.  Having a core full-time staff that can be enhanced by temporary workers will allow you the flexibility to expand and contract your wage bill in line with peaks and troughs in your business cycle.

Failure to be Forward Looking or Act promptly

It can be all too easy to get sucked into the immediate pressing needs of the business today, but it is important to look out over the next few months to spot any irregular payments that might put a strain on your resources.

Payments such as VAT or quarterly rent payments can be significant, and cannot be avoided.  It is important to factor these into any decisions you make about making other commitments, as it is important to build up cash reserves ahead of these items to ensure they can be paid on time.

So long as you have a rough idea of what your regular income and expenditures are, pulling together a high-level cash flow projection is a fairly simple thing to do, and once drafted, can be rolled forward to give you a sense of where you are.

Having prepared your cashflow, you may realise that there is a pinch point coming, meaning you need to obtain access to additional funding to get through it.  In cases like this, the need for timely action is even more important, as financial institutions will have some lead time built in to their approvals process, and so you will need to initiate conversations with them well ahead of when you need the cash to be in your bank account.

Ideally, you have considered what forms of fundraising could be available to you and have an idea of what documentation is required and the paperwork you’ll need to complete.  Too many businesses fail to consider this and find themselves unable to access funds simply because they have not been able to get their applications processed or have failed to pull together the required documentation.

Manage Expansion Tightly

Many successful small businesses run into serious cashflow problems when they’re growing quickly. While strong growth is a good thing, it carries risk and requires significant effort to ensure it’s well-managed. Sustainable growth requires considered and consistent investment – you should have a clear plan for returning profits to the business or seeking external funding. A plan for any cashflow emergencies that arise (as noted above) is essential for SMEs who are expanding.

Failure to Keep or Review Accurate Records

To be able to review receivable balances, and levels of inventory, or pull together high-level cash flows, a business needs to have up-to-date and accurate financial information available.  Today, the availability of cost-effective cloud-based accounting packages means that you can access your financials anywhere, anytime. For small business owners, this means you can stay on top of your bookkeeping and seamlessly work with your accountant and payroll provider.

It’s easy to log in and record expenses as you make them, chase overdue payments or review your profit and loss statement.  If you find that you are unable to stay on top of your accounts because you’re tied up with other aspects of your business, then it’s probably time to consider getting someone to help with this on a part-time basis, otherwise, you risk losing control of your business.

If you’re interested in learning more about finance & non-finance solutions and whether it could be the right funding solution for you, EFM Ireland offers a free 1-hour consultation to understand your business and suggest appropriate funding options. Contact the EFM Ireland team today via email or call 01442 8176.

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