Sales growth has to be managed correctly, or it can actually bring serious problems to a company. Few entrepreneurs ever consider this outcome because they believe all growth is good. But growing sales too quickly, or getting several very large orders, can create serious cash flow problems. These problems can sometimes be severe enough to derail your business permanently.
We have covered cash flow problems and solutions in a previous article. This article discusses the most common cash flow problems that occur specifically due to growth. It covers the following:
- An inadequate cash reserve
- Slow invoicing and collections
- Signing on too many clients that pay on terms
- Growing purchase orders
Problem #1: An inadequate cash reserve
A growing business can encounter cash flow problems if it does not have a cash reserve. Without a reserve, a company is unable to handle the inevitable problems that come with quick growth. The emergency cash reserve helps you cover business expenses during tight situations or while waiting for clients to pay. Furthermore, a cash reserve is an essential tool in the event of a recession. Every business should have enough cash in reserve to cover three to six months’ expenses.
The best solution is to build a cash reserve early on so that it is available when you need it. The process is simple but requires financial discipline. Start by determining how much money you need to keep in reserve. Most experts recommend three to six months, though this is just a guideline. If you are unsure, consider working with a CPA or similar professional.
Open a separate bank account and deposit a small percentage of your monthly profits. Keep depositing funds periodically until you reach your target amount. You can stop depositing funds once the account balance reaches the desired amount. Lastly, use the reserve account for emergencies only and replenish it quickly after using it.
Problem #2: Slow invoicing and collections
Companies that grow too quickly sometimes neglect to give their billing and collections activities the attention they require. This serious mistake needs to be corrected quickly. Otherwise, the situation will only get worse. Invoicing and payment delays affect cash flow and can create serious problems.
The solution is to implement a reliable invoicing and collections process. The process is simple. However, it must be used consistently. Follow these steps:
- Check your client’s business credit before offering terms
- Use written contracts
- Have clients confirm delivery and acceptance
- Invoice promptly
- Follow up regularly and professionally
Problem #3: Signing on too many clients that pay on terms
Most business-to-business sales are made on net-30-day payment terms. This means that companies spend money to deliver their product or service and then wait one or two months to get paid. The problem is that many small businesses cannot wait that long to get paid. They need funds to pay employees and suppliers. Ultimately, this situation creates a cash flow problem.
Growth can be a double-edged sword. It rewards companies that are well-prepared and managed. However, it can hurt companies that don’t have the financial resources to handle it. Let’s look at an example. The example oversimplifies the cash flows but provides a clear picture of this problem.
Assume that a business is growing its sales by $100,000 per month and that all-inclusive costs are 85% of sales. Invoices are collected at the end of the following month, on about net-60-day terms. On the other hand, business expenses are paid in the month they are incurred.
The first thing that becomes clear is that expenses exceed collections for the first six months. You can see this problem in the area marked in red. July is the first month in which collections exceed expenses.
However, this problem does not tell the whole story. The “Total Deficit” column tracks the cumulative deficit from all previous months. A number in parenthesis, such as “$(85,000)”, indicates a negative number.
The total deficit stays negative through December – a full year after growth started – as depicted by the area in yellow. Collections catch up with expenses at the end of January of the following year, as shown by the area in green. This business could have serious cash flow problems unless it has an emergency fund or financing to cover the initial deficits.
This problem is insidious and can grow undetected, at least initially. Business owners whose sole focus is on growing sales may not notice the serious cash flow problems until it’s too late.
You can solve this problem by creating a cash reserve to handle the initial deficit. We discussed this solution in Problem #1. Alternatively, consider providing clients with an incentive to pay sooner. Offering a 2% discount in exchange for a quick payment can often improve your collections and eliminate any deficits.
If neither of these options works, consider factoring invoices to smooth your cash flow until it becomes positive. Factoring provides you with immediate funds to finance slow-paying invoices. This advance improves your cash flow and allows you to pay expenses and grow. To learn more, read “What is Factoring?” and “Pros and Cons of Invoice Factoring. ”
Problem #4: Growing purchase orders
This problem is similar to the previous one but usually affects resellers and wholesalers. Small companies with a portfolio of successful products soon start growing quickly. This growth can be exponential and lead to very large orders. The problem is that these orders often exceed the capital capabilities of the business.
Like the previous example, these companies often work with commercial or government clients that pay in 30 to 60 days. However, many wholesalers also work with product suppliers who demand a prepayment or a payment upon delivery.
In the worst case, your company needs to pay for the goods and wait 30 to 60 days for the goods to be delivered. Once they are delivered, they must wait another 30 to 60 days to get paid by clients. If goods are manufactured overseas, the transaction can take as long as 180 days to conclude. As with the previous problems, these problems get worse the faster you grow.
The simple solution is to get payment terms from your suppliers while asking your clients to pay quickly. This arrangement effectively gets your suppliers to finance your business. However, this solution can be difficult to balance. Clients could unexpectedly decide to pay slowly, or suppliers could start demanding faster payments. And if this scenario happens, you’ll be exactly where you started.
If you cannot invest additional funds into your business to handle the larger orders, consider using purchase order (PO) financing. PO financing provides you with funds to cover supplier expenses. This funding allows you to complete the order and book the revenues. To learn more, read “What is Purchase Order Financing?”
We can provide you with factoring and purchase order financing at competitive terms. For more information, get an online quote or call us toll-free at (877) 300 3258.