7 Reasons Your Business May Be Struggling with Cash Flow— and How to Solve Them
In 2019, Quickbooks released a survey on the state of free cash flow for small businesses. What they found was important and insightful, though perhaps, to many business owners who know the challenges of entrepreneurship, not so surprising.
According to the report, 61% of small business owners regularly struggle with cash flow problems, and 69% of them are kept up at night over worries about having enough readily available funds to pay their bills. The survey also dug a bit deeper, revealing that 32% of those small business owners were unable to pay themselves, their employees, vendors or loans that year.
2020 was unsurprisingly worse, with the US Federal Reserve reporting 86% of business owners said they would need to ‘take action’ in the form of a loan or laying off workers if they lost revenue over two consecutive months, and 16% saying they would need to close their business, with the likely exception of psychics, mystics, and astrologers, who apparently did quite well that year.
Mercury-in-retrograde and economic disasters aside, it’s never been particularly easy to get sizable funds together when you’re small or first starting out, and having free cash flow can be more difficult in some industries than others.
The good news is that, looking beyond life’s unchanging circumstances, one of the main reasons business owners struggle with cash flow has to do with cash flow management— a skill you can learn, cultivate, and improve upon, as well as automate.
In this guide, we’ll start with a deeper explanation of what free cash flow is, how it’s calculated, the main factors that influence negative cash flow, and of course, how to solve them.
What is free cash flow and why is it important?
Cash flow is the money moving in and out of your business. 'Positive free cash flow' is when you have more money moving into your business than you have moving out— the thing every business needs and wants.
Positive free cash flow can be used to hire necessary employees, invest in equipment, expand marketing efforts, and more. It's also essential for paying creditors or paying off interest you might owe.
On the other hand, if you have less money coming in than out, then you have 'negative cash flow,' the demise of business.
Negative cash flow can point to poor sales, bad profit margins, costly business operations, and a number of other issues. That’s why it's important to understand and calculate your free cash flow.
How to calculate free cash flow
There are a few ways to calculate free cash flow. Each FCF formula offers a slightly different view of your finances. Let's start with the first free cash flow formula:
Cash flow from operations + interest expenses – tax shield on interest expense – capital expenditures = FCF
If you don't have any interest expenses factoring into your business, you can also use the more straightforward method that relies on sales and base taxes:
Revenue – operating expenses – taxes – operating expense investments = FCF
The above FCF formula is great for determining free cash flow. But, if you want to predict FCF, you need the discounted cash flow (DCF) formula. Discounted cash flow is used to estimate how much cash flow you can expect from something in the future. This is especially useful for investing and is frequently used in real estate.
Discounted cash flow is especially in-depth, and being the case, so is the formula to find it. Read up on discount cash flow to better understand how you can calculate this predictive type of FCF.
Lastly, there's the formula for finding your unlevered free cash flow. Unlevered cash flow is your FCF without factoring in any interest payments. This is useful for getting an idea of how your company would be performing without any kind of interest or debts.
Gross revenue – capital expenses – taxes – working capital = Unlevered FCF
While unlevered free cash flow isn't necessarily practical for daily use, it can be a great way to see how your company could be doing if you had all debts and interest out of the way. If you need more immediate, actionable information, the first two formulas are your best bet. You can also use Shopify's cash flow calculator if you'd rather skip the math.
Now, let's figure out how to boost your free cash flow.
7 Reasons Your Business May Be Struggling with Cash Flow— and How to Fix Them
If you've just run FCF calculations and you're looking at a concerning balance sheet, don't lose hope. There are ways to drive up your operating cash flow in both the short and long-term. Here's a few signs to look out for if you're struggling with your cash flow, and how you can improve them.
1. Not receiving payments quickly enough
According to Quickbooks, 66% of small business owners report that the time it takes the money to process after receiving a payment has the largest impact on their company’s cash flow, compared to not getting paid by customers or clients within the payment terms, which accounts for 34%. In fact, 31% of small business owners estimate it takes more than 30 days to get paid by customers, clients, vendors or banks, with the average wait being 29 days.
A simple solution to this problem is instant payouts. It can be both frustrating and harmful it can be to have to wait days or months to receive payments for your sales. That’s why Brex recently launched instant payouts for our customers who sell through Square, Shopify, Amazon, and Stripe, allowing them to access their sales earnings from these platforms instantly.
Learn more about instant payouts here, and feel free to read up about how our team launched instant payouts if you're curious.
2. Not having a clear view of your company’s spending
When we talk about not having a clear overview of your spending, we really mean the whole gambit: your earnings, expenses, amounts owed, and amounts owed to you. Many small business owners don’t have an adequate, easy, and/or detailed overview of their spending. This is partly because:
- They keep their funds in a personal bank account, making it harder for business owners to distinguish their business from their personal expenses and easily know what funds they’re gaining or losing.
- Because they don't separate their business and personal funds, they miss out on expense management features and accounting integrations that certain bank account alternatives offer— features that would otherwise help them understand their spending.
If you keep all of your business funds in a personal checking account, know that separating your personal from your business expenses is important, and that there are business account options available to you even if you don't have a business credit score.
3. Not having a good pricing strategy
The right prices on products and services play a large role in net income and overall cash flow, but many business owners don't have a clear pricing strategy. A good rule of thumb is to go through your books and look at any line item that's a product or service being sold. Then, review the process and materials needed to make that product or provide that service, and factor in the cost.
From there, consider looking at any competitors and see what their present value is for similar products or services. Grossly undercutting your competitors might seem like a good way to drive traffic, but it's a bad way to drive profits.
If you're well below your competitors, consider increasing your prices by a responsible amount. When done right, this can increase the amount of cash coming into your business very quickly. A small increase shouldn't have a large impact on business.
When in doubt about how much to increase your price, do some A/B testing with prices or ask prospective customers (or even friends and family) what prices are appropriate.
4. Not auditing your operating expenses
High operating expenses can quickly and continually eat into your free cash flow. Just like you audited your product cost, go through your operating expenses and ask yourself if you truly need everything you're paying for. For example, you might find you're paying for software you no longer use. It's also not a bad idea to include your utilities in this audit, as it's possible a quick call to your utility providers can lower your bill through a renewed agreement.
5. Not auditing your inventory
You should also audit your inventory. Outside of current assets that actively contribute to your company's success, you should be limiting what sits on your shelves for too long. If there's a certain product that's fallen in popularity, consider cutting its price, selling it, and freeing up that space. This is space that can be filled with bulk orders of materials, which can in turn save you money on production down the road.
6. Not negotiating with vendors
Vendors are essentially business partners, especially when you've fostered a great relationship through vendor management. If you have a great relationship with your vendors, reach out and talk to them about reducing prices for the services they provide. There's always a chance they can give you a better deal in exchange for a longer term or even as a thank you for being a loyal client.
If you have a vendor that you've been unsure about for some time, reassess your relationship. Maybe it's time you find a new vendor with better prices and better service.
7. Operating as a sole proprietor or sole trader
70% of small business owners operate as sole proprietors or sole traders, which, according to the SBA, makes it harder for them to get loans and investments.
That said, every business structure has its advantages and disadvantages. No one can tell you which one is right for you except a tax or legal professional, so you should always seek personalized expert advice before making any decisions for your business.
Find freedom with free cash flow
Free cash flow is a must, and with the above tips you can get your business on the fast track to a positive cash flow. But, you need to stay vigilant and continue performing audits, price optimizations, and vendor negotiations.
Healthy free cash flow takes work to achieve, but the end result is both peace of mind and the freedom to grow your business. When your cash flow is in the red, you're unable to make the right moves, hire the right people, and grow in the right direction. But, you can achieve positive free cash flow with a little fine-tuning. And when you get there, you'll be reminded of the reason you went into business in the first place: total freedom.