Growth can actually bring serious problems to a business. Few entrepreneurs ever think about it because they think all growth is good. But growing sales too quickly, or getting a single very large order, can create serious cash flow problems. These problems can sometimes be serious enough to derail your business – permanently.
We have covered cash flow problems and solutions in a previous article. In this article we discuss the two most common cash flow problems that occur specifically due to growth. We are also going to address ways to solve these two problems.
Problem #1: You sign up more clients, who pay in 30 to 60 days
Most business-to-business sales are made on net-30 day to net-60 day terms. Basically, companies spend money to deliver their product or service and then wait one or two months to get paid. The problem is that suppliers and other expenses must often be paid quickly. Payment is either due upon receipt or at the end of the month.
As a result, cash flow problems can escalate quickly.
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 $100,000 per month and that all-inclusive costs are 85% of sales. Also, assume that invoices are collected at the end of the following month, on about net-60 day terms. Business expenses, on the other hand, are paid in the month they are incurred.
The first thing that becomes clear is that expenses exceed collections for the first six months. You can see this problem in the area marked in red. July is the first month in which collections exceed expenses.
However, this problem does not tell the whole story. The “Total Deficit” column tracks the cumulative deficit from all previous months. A number in parenthesis, such as “$(85,000)”, indicates a negative number.
The total deficit stays negative until 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 a reserve 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 revenues 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. 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 dramatically and eliminate any deficits.
If neither of these options work, 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 #2: You get increasing orders or a very large order
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.
Much like the previous example, 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 payment upon delivery or, worse, a prepayment.
In other words, they need 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.
Long and growing cash flow cycles can create serious problems. Unless the problems are fixed, you may have to decline orders. This situation can affect client relationships and lead to loss of business.
You can solve this problem if you can get payment terms from your suppliers while asking your clients to pay quickly. 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?” or visit our learning center.
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.