More than half of all new businesses fail in their first year, and making it that far doesn’t mean you’re safe. Small and medium sized businesses don’t have the deep pockets that large enterprises do, which is why even short-term cash flow problems can sink an otherwise successful business.
Quick takeaways if you’re in a hurry
- SMEs work on tighter budgets than large companies, and that means even small financial problems can sink an unprepared business.
- The most common problems that can sink otherwise good small businesses are: unsustainable growth, clients who pay late, and a sudden loss of credit.
- These issues can’t be totally avoided, so SMEs need prearranged facilities that allow them to manage these kinds of cash flow problems when they occur.
The top reasons SMEs run out of cash
How can a business unexpectedly run out of cash?
There are a lot of different reasons that your business could suddenly run into liquidity issues, but let’s take a look at some of the most common culprits to give you an idea of where trouble is most likely to rear its head.
Surprisingly, too much success too quickly can wreak havoc on your finances. High demand for your products can overextend your ability to provide services, which means you need to build up your business’ infrastructure with more employees, more tools, more materials, and maybe more management support.
If, for example, a long-time client suddenly wants to scale up their service by an order of magnitude, you might end up trying to scale your operations up part-way (as your budget allows), only to lose the client entirely because they’re now unhappy with the service you can provide with your lagging infrastructure. You won’t be able to recover the investment you made in the time you had planned, and your revenue is now even lower than before you made that investment.
Clients who pay late
An issue every business owner is familiar with is clients who pay late. It’s so common that entire industries are built collecting those overdue debts. Unfortunately, most SMEs don’t have time to wait for collections agencies to do their work. Businesses need reliable revenue to pay for operational costs. When a small business doesn’t get paid, things go downhill fast. Tools break and don’t get repaired, materials run out, payrolls fail, and employees leave.
Sudden loss of credit
Sometimes everything will be going fine, until you get a letter in the mail letting you know that your bank is closing down your line of credit. This essentially pulls the safety net out from under your business. If you were counting on that facility to cover any expenses due to another issue (like a late payment from a client), you’re out of luck.
These issues pose massive risks for SMEs all over the world, and the most important way to fight them is by understanding and making use of the financial tools available to SMEs.
What can an SME do to protect itself?
There are a variety of different financial arrangements that SMEs can make with business finance firms to protect themselves from these common cash flow problems:
Free standby finance facilities
A standby finance facility is essentially a business loan that is ready to go, but won’t be issued until you need it. It doesn’t cost anything to set up, and you don’t have to pay anything until you use it. They’re designed to provide immediate financing exactly when you need it. They’re perfect for situations where you suddenly need a significant injection of funding for growth, or to cover an unexpected budget shortfall due to seasonal changes or a loss of credit.
Invoice financing allows you to sell outstanding invoices to a financial institution for most of their value. They collect the payment from the client, and you can get paid within hours of issuing the invoice, instead of when it comes due.
There are a few different types of invoice financing depending on the kind of institution you’re working with. Large banks often require you to sell them all of your invoices for a year or more, and come with a variety of other strings attached.
Smaller lenders can offer much more flexibility and allow you to use invoice financing as a tool to give yourself a quick advance on your income exactly when you need it, and only when you need it. The trade-off is that the cost for every individual invoice tends to be a bit higher. Despite that, unless you plan to have most or all of your invoices financed, it’s still a much more affordable choice.
The threat of running out of cash costs small business owners a lot of sleep all over the world, but they can rest easy knowing that their backs are covered if they just take a few clever preventive steps.