Sales growth has to be managed correctly, or it can actually bring serious problems to a business. Few entrepreneurs ever consider this outcome because they believe all growth is good. But growing sales too quickly, or getting several very large orders, can create serious cash flow problems. These problems can sometimes be severe enough to derail your business permanently.
We have covered cash flow problems and solutions in a previous article. This article discusses the most common cash flow problems that occur specifically due to growth. It covers the following:
- An inadequate cash reserve
- Slow invoicing and collections
- Signing on too many clients that pay on terms
Problem #1: An inadequate cash reserve
A growing business can encounter cash flow problems if it does not have a cash reserve. Without a reserve, a company is unable to handle the inevitable problems that come with quick growth. The emergency cash reserve helps you cover business expenses during tight situations or while waiting for clients to pay. Furthermore, a cash reserve is an essential tool in the event of a recession. Every business should have enough cash in reserve to cover three to six months’ expenses.
Solution
The best solution is to build a cash reserve early on so that it is available when you need it. The process is simple but requires financial discipline. Start by determining how much money you need to keep in reserve. Most experts recommend three to six months, though this is just a guideline. If you are unsure, consider working with an accountant or similar professional.
Open a separate bank account and deposit a small percentage of your monthly profits. Keep depositing funds periodically until you reach your target amount. You can stop depositing funds once the account balance reaches the desired amount. Lastly, use the reserve account for emergencies only and replenish it quickly after using it.
Problem #2: Slow invoicing and collections
Companies that grow too quickly sometimes neglect to give their billing and collections activities the attention they require. This serious mistake needs to be corrected quickly. Otherwise, the situation will only get worse. Invoicing and payment delays affect cash flow and can create serious problems.
Solution
The solution is to implement a reliable invoicing and collections process. The process is simple. However, it must be used consistently. Follow these steps:
- Check your client’s business credit before offering terms
- Use written contracts
- Have clients confirm delivery and acceptance
- Invoice promptly
- Follow up regularly and professionally
Problem #3: Signing on too many clients that pay on terms
Most business-to-business sales are made on net-30-day payment terms. This means that companies spend money to deliver their product or service and then wait one or two months to get paid.
The problem is that many small businesses cannot wait that long to get paid. They need funds to pay employees and suppliers. Ultimately, this situation creates a cash flow problem.
Growth can be a double-edged sword. It rewards companies that are well-prepared and managed. However, it can hurt companies that don’t have the financial resources to handle it.
This example oversimplifies the cash flows but provides a clear picture of this problem. The company is a new business with $100,000 in initial sales. It adds new clients every month, increasing its revenues but also its expenses.
| Date | Sales | Expenses | Collections | Cumulative Deficit |
|---|---|---|---|---|
| January | $100,000 | ($80,000) | $0 | ($80,000) |
| February | $105,000 | ($84,000) | $100,000 | ($64,000) |
| March | $110,000 | ($88,000) | $105,000 | ($47,000) |
| April | $115,000 | ($92,000) | $110,000 | ($29,000) |
| May | $120,000 | ($96,000) | $115,000 | ($10,000) |
| June | $125,000 | ($100,000) | $120,000 | $10,000 |
Note: This table can be scrolled left/right on mobile devices. Tap on the screen if a scrollbar does not appear.
The business has simple finances. Sales grow by $5,000 every month and operating costs are 80% of sales. Clients pay on Net-30 terms, so invoices are collected the following month. However, business expenses are paid shortly after they are incurred.
The business is technically profitable but has financial problems. It operated with a cash deficit for the first five months. The deficit only cleared in June, leaving a small surplus.
This situation is common for new companies and businesses growing quickly. They are profitable, but expenses can overwhelm its cash reserves at times.
This problem is insidious and can grow undetected, at least initially. Business owners whose sole focus is on growing sales may not notice the serious cash flow problems until it’s too late.
Solution
You can solve this problem by creating a cash reserve to handle the initial deficit. We discussed this solution in Problem #1. 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 and eliminate any deficits.
If neither of these options works, consider financing your invoices to smooth your cash flow until it becomes positive. This solution provides you with immediate funds by financing slow-paying invoices. This advance improves your cash flow and allows you to pay expenses and grow. To learn more, read “What is Invoice Finance?” and “Pros and Cons of Invoice Finance.“
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