Sources of Negative Cash Flow and How to Manage it? 

“Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cashflow matters most.”- Peter Drucker

Cash flow shows the movement of cash in your business. It signifies the inflows and outflows of cash of a company in a given period. The firm prepares cash flow statements to report sources and usage of money over a period. When you have more incoming than outgoing cash, it is called positive cash flow and is favorable for your business. However, when cash outflows exceed the cash inflow, it is negative.

So one needs to keep track of their cashflows cautiously.

 

What is negative cash flow?

As said earlier, negative cash flow is when the outgoing cash of your business is more than the incoming cash. Your sales are alone insufficient to cover all your expenses. Furthermore, you need to source money from investments and financing.

You can experience cashflows at different times, depending upon business operations. For instance, heavy investment in plan installation for expansion may lead to outspending. As a result, you will have a negative cash flow. Another example of negative cash flow is insufficient cash to cover your expenses as your customers’ bills are due. Hence, this negative cash flow exhibits the poor timing of income and expenses.

However, it is necessary to note that negative cash flows are not inherently bad. If you are a startup, having negative cash flow is expected, and a company may spend and keeps a negative cash flow for future higher profits. So, a business of any scale experiences negative cash flow. But to fulfill the long-term objective of your business, understanding the causes of negative cash flow and mitigating those is vital.

Let’s first understand the reasons for negative cashflows and how negative cash flow impacts your business.

 

What are the reasons behind negative cashflows?

Here’re the five most common reasons which lead to negative cashflows, which you must entertain:

1. Low Profits

Like any other business, your first income source is profits. Various reasons could lead to low or no profits:

• Ineffective marketing strategies and sales.
• The low productivity in the manufacturing units.
• The expensive operating costs or undercharging for your offering.

These could often lead to shortcomings of cash to keep operations afloat.

2. Overinvestment

Investment by a company or an individual requires a strategy considering various factors. For instance, you install a plant thinking it will boost production and profits without analyzing the extent of the actual demand for your products. But eventually, you realize the repair and maintenance cost of the plant is more than your increased profits. At last, you have this plant instead of the cash for daily operations. So, overinvestment may behave against the best interest of your company and shareholders. As a result, it can swiftly lead to negative cash flow.

Also read: The Rich Dad’s Cashflow Quadrant.

3. Unexpected Expenses

The most common reason is unexpected expenses, including insurance premiums, equipment maintenance, taxes, and shrinkage. These unexpected expenses are expenses you, as a business owner, couldn’t forecast in a financial plan. So you must allocate funds to deal with the unpredictable cash flow and prevent negative cashflows.

4. Due Customer Payments

According to a 2019 QuickBooks report, late payments can lead to a damaging negative operating cash flow cycle. In the US, SMB owners experienced an 81% increase in outstanding receivables from 2018-19. Around 71% of respondents stated that late payments impacted their ability to cover supplier payments.

These stats signify the importance of clear payment terms in invoices. The past due customer payments will result in negative cash flow, and you will struggle in floating your business operations.

5. Expedited Growth

You always want your business to grow, which is only possible with a strategic plan. Your efforts and cash will only succeed if there is a structured plan for business growth. Expanding your company at an early stage is a red flag. Besides, several growth issues impact your cashflows. For instance, haphazard hiring, focusing only on short-term wins, and mismanaged financial tracking.

After identifying the sources of negative cash flow, read how it can impact your business. 

Negative Cashflow’s Impact

The reflection of poor cash flow management can be seen all over your business. Your stakeholders, especially investors, check your cash flow statement before making an investment decision. If the consistency of positive cash flow is missing, it leaves a negative impression. This is why many investors will back out from investing in your company. Moreover, for the same reason, banks give your firm no or higher fixed-rate interest loans. Besides depicting the poor financial health of your business, it also reflects the following:

• The inability of the company to meet daily operational obligations
• Business Losses
• Stunned Growth
• Hampered Dividend Payout
• Poor or Inefficient operations

Being a business owner, you want to avoid facing above stated situations. Therefore, you can take a few measures to manage negative cash flow. 

 

3 ways to win over negative cash flow

Negative cash flow is not a result of a single act. Similarly, managing it will be something other than a plug-and-play situation. It requires getting to the depth of your books and the sources of negative cash flow. Ultimately this will help you draft a plan to manage negative cash flows. You must be strategic in your spending and investing in keeping a positive cash flow. Besides studying your spending and investing activities, you can take these three measures: 

 

• Periodically create Cash Flow Statements and forecasts regularly.

Cash flow management is also called a statement of changes in financial position. It is a document that shows what happens to your company’s cash. It shows the ability of your company to operate in both the short and long term. The cash flow holds immense utility for your business. Preparing and strategically analyzing the cash flow statement will give an accurate picture of your working capital. Forecasting the cash flow with an estimated cash budget is a boon for your business. It will leave you with the answer of do you have enough cash to handle the next month’s obligations. 

• Review and Reduce the Expenses

Keeping an eye on your books will help you learn about your business spending. Reviewing cash outflow will give you a robust grip on your cash flows and prevent any financial downturn. Analyze all your expenses and see if there is an affordable alternative available or if you could cut out some expenses. Eliminating unnecessary expenses will lead to the optimum utilization of your cash.

• Forecast unexpected expenses and create an emergency budget

An unexpected expense can drain your cash, leaving you with negative cash flow. If you are on a tight budget, try to mindfully allocate your financial resources to an emergency budget. This way, you always have enough reserve cash to sustain any unforeseen expense. 

 

Conclusion

Positive cash flow is one of the best Key Performance Indicators of your business’s profitability and liquidity than other indicators. It portrays that you have enough cash, which attracts investors, employees, suppliers, and financing institutions. 

Be it the requirement of working capital or acquiring assets for long-term growth, you need cash. Besides understanding the cash flow statement, it also requires an industry expert to forecast your cash requirements and the best financing sources. 

Considering the importance of cash flow statements for your business, having professionals for expert advice will help you make informed decisions. If you’re looking for advice on cash flows or to relive your cash flow management activity, schedule a meeting with SKB Accounting, who altogether has your back!