Why you may have cashflow problems

Why you may have cashflow problems

English: Cost-Volume-Profit diagram, showing B...

From time to time most businesses have cash flow problems.

The trick to overcoming these is to understand your business and I mean really understand it.

The key questions to ask when you have cashflow problems are:

  1. Are customers paying late?
  2. Are suppliers asking for payment earlier?
  3. Have you had a large payment recently?
  4. Have your expenses increased?
  5. Have your sales reduced?

If the answer to all these is no, then it usually means that your business may not be profitable enough. It’s easy to hit cashflow problems gradually without realising that your costs have increased over time but you haven’t increased your prices to customers or certainly not increased your prices enough.

What is a ‘good’ profit or margin? My advice is that you should make this as high as you can.

For example, your gross profit or margin should be at least 100% or more – that is the difference between the unit sales price and supply costs excluding overheads, So if cost of supplying the produce or service namely the variable costs per unit are £100, then your price should be at least £200. Usually overheads, rents, non product related staff costs and all other incidental costs are then deducted from this gross profit to get the net profit. If this gross profit, also called the ‘contribution to overheads’ just covers your overheads, this is called the break even point and the sales price, sales volume etc is called the break even price or volume. Usually overheads taper off at a certain point in activity and once the break even point is exceeded in sales volume, profits tend to increase. However, no one wants to be in business just to break even, at least not in the long-term!

Most businesses analyse their pricing, compare these to their costs and also to competitors’ pricing but are usually shy of increasing them beyond any competitors’ price. This may not be enough for your business if you provide a better product or service. Of course if you have higher costs, you should manage your supply chain and if you have good relations with your suppliers, you should be able to reduce your costs to achieve higher margins. If it’s the overheads that have gone up, then you need to reduce these. If reducing costs or increasing prices is impossible, then you really need to evaluate the long-term strength of that service or product and maybe the strength of the business as a whole.

The other problem is that a lot of businesses do these price comparisons and cost checks as a one-off annually whereas the competition may increase or even decrease their prices more often and you don’t want your customer to be the first to inform you of that!

You have to keep track of your pricing, contribution margins and compare these to your forecasts and also the competitors’ margins. You should do this regularly and preferably have these at least in your monthly financial statements.

So if you do run into cashflow problems and can’t think why, look at your pricing.

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