A large firm with a strong balance sheet, investors, and working capital usually has the resources to withstand a negative free cash flow for financing business activities and covering expenses. New businesses without many investors do not, and often struggle with expenses. Knowing what it is can help you identify when it might happen so you can take steps to cut expenses. Doing so won't just restore revenue and profit but might just save your business.
Can a company have negative free cash flow? It certainly can, since that is the opposite of the positive cash flow that you want.
Negative cash flow is one challenge that a small business might face, especially early in its growth as expenses add up. Assume you have a particular period where you have $5,000 in your overall outgoing expenses, but you only bring in $2,500 in actual revenue. That month is one of the negative cash flows rather than positive cash inflows.
You have negative cash flow anytime your business has less money incoming than outgoing. You can't cover all your overhead costs, expected and unexpected expenses, just based on your sales. You'll wind up using financing and investments to make up any difference.
Negative cash flow isn't always a result of poor financial planning, but it can be if it goes on too long. The kind of negative cash flow you have can make a difference. For example, low profit margins are a huge cause for concern.
Initial Negative Cash Flow
Negative cash flow is crucial when a firm starts because the organization might actually go several years before generating a net profit. This is a time to put resources into brand development and marketing. Some businesses that generate profit too fast might be due to serious cost-cutting moves that strain relations with customers and employees alike.
Temporary Negative Cash Flow
Temporary negative cash flow can happen during times of expansion or in seasonal industries where profits happen only in specific periods of time. Retail clothing, holiday retailers, construction companies, and school supply businesses are all examples of this. Short stretches of negative cash flow might also happen when there are growing pains, such as employees getting raises, buying new equipment, or other one-time overhead expenses coming up.
Chronic Negative Cash Flow
If expansion isn't the cause for losing money, then there might be a problem. Unexpected negative cash flow might indicate deeper problems, and chronic negative cash flow might lead to layoffs and unpaid bills. Things can escalate in severity from there.
What Impact Might Negative Cash Flow Have on Your Business
Negative cash flow can impact any business, whether it's temporary, the result of competition or natural disaster, or just a consequence of sudden regulatory changes. When it happens, it can be an opportunity to assess business growth and evolution as a business. Studying negative and positive cash flow patterns can help you analyze and predict your business growth potential.
However, a negative cash flow can result in a cash crunch that might delay payments to vendors and suppliers, which strains relationships and can even impact your team of professionals. If you have to supplement negative cash flow with debt funding or equity infusion, then you might see interest rates and bank charges go up. You'll also dilute your equity ownership which can impact long-range strategies.
Negative cash flow can have many meanings, but it can also have even more causes. Here are some key takeaways.
1. Minimal Profits
Profit is the primary source of business income, and that happens if you sell goods and services. Those goods and services do cost you money to produce, however. Your profit happens when your incoming revenue is more than the outgoing expenses you have. Low profit can happen for many reasons, including a lack of productivity, uncontrolled spending, and poor execution of operating activities.
2. More Financial Expenses
You should always have a financial plan for any specific period of time, but unplanned expenses might pop up at any moment. That means you might exceed your cash inflow threshold. Malfunctioning equipment might require repairs or replacement, or raw material prices might spike. Many things might boost your overhead costs, and a sudden spike can certainly upset the balance of your company's revenue versus cash flow.
3. High Overhead
Overhead is the name for all ongoing costs that you need just to keep the lights on and the doors open. You have these operating expenses whether your business is successful or not. However, if they all add up to being too much of your budget, then your cash flow might be crippled. Your overhead should stay within a certain percentage of your budget, and that number might vary based on what industry you are in.
4. Accelerated Growth
Growing your small business should always be a priority, but you need a plan. It's possible to grow too fast and land your company in the red. Growing up fast might impact your cash flow with financial mismanagement, haphazard hiring, losing focus on the bigger picture, and chaotic business operations. You might quickly find you need more team members and even additional locations for future growth but not enough healthy cash flow now to support the resources necessary.
5. Customers Falling Behind
Customer credit can endear many consumers to your business, but it might also backfire later on. If you have enough clients that don't settle debts on schedule, your revenue will suffer from goods and services already produced. This can create a domino pattern in the future that impacts a lot of other things. While a few unpaid invoices might be expected at all times, too many late payments will start to backlog your cash stream.
6. Investing Too Much
If a firm spends excessively on products, projects, or additional equipment that isn't critical, it can also impact its cash flow. In many cases, such things just drain funds and don't actually boost your profitability. Overinvesting works against what's best for your company, and shareholders might turn sour on your practices and processes as a result. Investing more funds in your business is smart, but you need to be efficient about it and pick your expenses carefully.
7. Pricing Too High or Low
If you price your goods or services over the market, you won't get as many clients. If you go under, you might kill your company's profitability. Do feasibility studies and market research to see what price points your industry's market will support, and then stay close to those numbers.
8. Improper Financial Planning
Your budget needs to be detailed and well-organized. If you don't even have one, then you're putting your company at risk. You're also going to be wasting your revenue with blind spending.
Poor cash flow management can impact how viable a small business is, particularly if it's a persistent problem. Investors might get skeptical about how your company is doing if ROI isn't a sure thing.
- Stunted Growth: The more time a business spends managing its negative cash flow, the less time you have to put into growing your business. The smaller your budget gets, the less ability you have to even start tackling your growth goals. Your reputation and employee morale might take serious hits.
- Arbitrary Budget Cuts: Making your operations more efficient is great if they're sustainable changes. Cutting the budget just to have more cash can mean hurting your company's operations more than they can withstand.
- Promotional Deficiencies: Cutting marketing is one of the first things many companies do when facing a cash crunch. That will obviously hurt potential new sales, but it might also hurt your brand reputation among your existing customers.
- Business Losses: Customers are likely to notice when your product or service quality suffers, and they may expect discounts or even lower prices as a result. You might even lose some of them for good.
- Poor or Inefficient Operations: Squeeze your processes too tight, and you might wind up without enough resources to continue producing goods and services you need to generate revenue from, extending your cash flow negative state.
- Stymied Dividends: Dividends might not be possible to pay out if you don't have enough cash. Investors might not get returns on their investment, and that can strain those relationships.
You can achieve healthy cash flow. By cutting costs, you'll move from negative to positive cash flow.
1. Mind Your Money
You should know where every dollar is going, why it's going there, and when. You need to monitor your business's financial health and review financial reports and your cash flow statement at least once a month and maybe even more often than that. Just reviewing all this information might help open your eyes to specific problems or points of concern that you can negate with some simple attention. Cash flow statements will always help you see what's going on.
2. Track Your Inventory
Inventory valuations should happen quarterly. See what goods don't have much demand or aren't moving very fast. Deadstock might impact your cash flow. Minimize how many of these buyers are in the future. Then, liquidate what you already have or discount them to move them out faster. Supply chain disruptions might impact your incoming cash, but they can also be an opportunity to learn how to manage your inventory better than ever.
3. Spend More Efficiently
If you lease or rent anything, you get to use it without the heavy spending that might happen with buying something. Monthly payments are much better on small business cash flow than huge one-time purchases. Pay in installments for anything you can. Buy supplies in bulk for volume discounts. If possible, partner up with similar businesses to yours for collective buying power.
4. Prevent Delayed Payments
Payment delays from customers can mean your own company delaying payments. Track payment turnarounds so you have some idea of how long the average invoice takes to get paid. You can build a lead time into your budget between invoices getting paid to avoid negative cash flow. Spreading out payment terms throughout a month might help if you have a lot more money due in a short period of time.
5. Make Invoices Easy for Customers
Many customers are used to one-click payment options, so include such a feature when you send invoices out. Electronic and digital payment modes have better usage rates and are faster for your business. Partial payments can help your cash flow crunch and engender goodwill with customers. Invoices should be easy to read with clear due dates and information about late payment fees. Send invoice reminders before the payment is due.
6. Negotiate Everything With Vendors
Your vendors are going to list specific prices and payment terms. You'll often have to accept them for what they are, as your own business is unlikely to move off its own price points. However, anytime you can do so, negotiate with vendors.
Even minor discounts or extensions on your payment terms might make a huge difference in the business's cash flow. Don't overdo it, however, as you don't want them to tire of your constant haggling. Stay within the confines of mutually beneficial relationships.
7. Think Ahead about Cash Flow Forecasting
Preparing your company's cash flow forecast lets you estimate future operating expenses and income. From there, you can build an accurate budget and make better plans. Analyze your performance from the past year and calculate the expected inflow from customer receipts and operating expenses from payroll and vendor payments.
Monthly and quarterly forecasts help you nail down seasonal changes, understand your financial statements, and give you the chance to improve cash flow.
You don't have to learn how to do all this alone. Count on our financial planning services for help.
Running a negative operating cash flow is something that can happen to any small business owner, but it can be dangerous for a small business. If there is too much cash outflow for too long, you'll run out of reserves and resources that keep your business afloat. If you operate in Chicago or the surrounding areas, then contact our CPA firm for cash flow management services in Illinois.