Stress about money is part of being a business owner. When the bank account is low, and bills are due, there’s an automatic sense of panic. There must be more money to borrow from somewhere. This means a call to a bank for a loan or line of credit. But this isn’t the solution to every pinch. Sometimes it’s not about having borrowed money. Sometimes it’s about capitalizing on what’s already in the business.
Understanding whether it’s a cash flow issue (money management) or capital shortage is important. One acquires money from outside resources, the other begs for better management of current resources. Failure to identify the proper issue will either saddle a company with debt it didn’t require or force a company to exist without a necessary solution for months longer than it should have.
When Money Problems Actually Refer to Cash Flow Issues
Cash flow issues manifest as money shortages, but they are different from capital shortages. A capital shortage means that the business does not have access to enough total resources at the present time to sustain itself, let alone grow. A cash flow problem means that there is enough money, it is just sitting in the wrong spots at the wrong times.
Consider when the problem occurs. If problems arise repetitively at certain times each month, most typically around the time of payroll or rent due, chances are it isn’t a shortage but a cash flow issue because money will come into play eventually; it is simply coming in after the business has needed it. Companies in this predicament have high sales and good operating income but don’t have enough cash on hand weekly.
Days past due on invoices also signal that cash isn’t a problem; it’s stuck in limbo. Invoicing customers over 30-90 days signals that the revenue has already come in, albeit waiting for someone else’s bank account to bring it in while vendors demand payment in 15 days. This creates a gap. It’s not a shortage; it’s a lack of cash movement.
Consider inventory. Products that customers have yet to purchase signal cash turned into material assets that are sitting beyond what is desired and, therefore, prohibiting cash flow. Seasonal businesses have this issue. They stock up on inventory for the busy time of year, yet when things slow down, it’s hard to pay expenses because there is too much money tied up in inventory instead of cash on hand.
When Borrowing Actually Makes Sense
True capital needs look much different from projections that support growth and development, where resources beyond what can be currently acquired cannot be attained. For example, opening a second location will need actual new money (deposits, equipment, initial inventory, operating expenses) before it can gain traction to be profitable.
It makes sense to borrow for equipment purchases of this nature as well. For example, a contractor needs special equipment worth $50,000 that will help him generate $100,000 more annual revenue. He might be able to save for it at $4,000 per year for ten years, but then he’s lost out on $200,000 in profitability along the way waiting for equipment construction since savings created $40,000 interest-laden debt over time but didn’t create value until 10 years later when cash was saved up enough to afford. Financing becomes an intelligent decision because paying higher loan/interest fees becomes palatable since the equipment pays for itself and generates additional revenue well beyond the borrowed expenses.
In these situations, taking the time to compare various business loans and financing structures makes sense since all companies need different terms depending on who they’re asking and under what type of loan and interest structure.
Emergencies that prohibit operations make sense under which financing is appropriate as well. Restaurants with busted HVAC systems or computer systems with broken parts need immediate repairs that cash flow arrangements may not support. Otherwise, if they wait until there’s enough money through effective cash flow strategies, and lose out on business, they lose more money than taking reasonable loans per implementation.
How Most Companies Get Cash Flow Issues Wrong
Reforming cash flow does not require complex financial engineering; more often than not, it comes down to three components: moving cash collection faster, slowing down necessary expenditures or reducing requirements for cash in general within operations.
For example, billing makes all the difference; shifting from net-60 terms to net-30 cuts waiting down by half. Offering slight discounts (2% if payment comes through within ten days), while seemingly trivial, often costs less than waiting through a bunch of weeks (especially if collections have dead time). Many companies balk at this lack of professionalism; however, typically customers don’t care how fast they get billed, they just pay what’s on the invoice.
Similarly, paying through credit cards gets payments into accounts within 1-2 weeks instead of three weeks or longer. Yes, processing fees cut into margins and dollars down the line, but it’s better than having no cash available now. Most do work in numbers ultimately, and faster payments make more sense than delayed deposits, even if they cannibalize certain credits stretched across margins down the line.
On the expense side, many companies can negotiate payment terms better than they have before. Vendors are often willing to provide 30-day terms instead of 15-day ones, but only if someone asks. Sometimes companies justify them due to client history with consistent patronage. This allows operational breathing room without jeopardizing staff allocations.
Inventory management is rarely examined until there is a financial crisis – but often holds the most cash available. For example, ordering more because per-unit costs drop in bulk is fruitless for anyone whose rent payment is next week and has additional perishable product collecting dust on shelves for months waiting for purchase due to peak-season arrival orders. Companies with seasonal trends fail to recognize that their gains must support their years ahead because they could overstock but fail to recognize how much those losses could become in debt over time because they undervalue their inventory based on demand instead of possible holdings.
When It’s Hard to Distinguish Between Both Needs
Some situations truly blur the line between cash flow and capital needs. Expansion creates an odd predicament in which a company succeeds but is perpetually broke; when each sale requires inventory purchases/materials needed for production/hired staffing/overhead before customer revenue catches up, growth looks promising, but immediately caps out available cash since it consumed everything and then some (hired help) offered limited additional restock resources.
While this isn’t exactly a cash flow problem (the business is modeled well), nor is it exactly a capital shortage (sales are occurring), it creates a working capital problem since one needs money to create revenue that ultimately fosters everything else from within but cannot bridge that gap immediately.
Seasonal business works well like this too, a ski resort or camp may earn 80% of its annual revenue within two months but requires cash flow action during non-business months – However, this is not necessarily a permanent capital shortage as it’s acceptable due to projections, but it’s also not necessarily an ongoing cash flow problem as it’s predictable discrepancy that either requires large cash reserves throughout the year or forceful finance brainstorming options, with structured operational sensibility, to cover those average gaps.
These situations often need a hybrid solution, better cash management to prevent gaps plus financing ideologies to bridge what cannot be eliminated through timing improvements alone.
How To Make the Correct Decision
When moments of panic set in, and prior to any hasty emotional decision, it’s best to start with what’s real versus what’s perceived based on feelings. Chart an actual dollar projected analysis over a three-month time span that shows where dollars come from and where they go during respective weeks/months; from here, if total deposits exceed total expenses over the entire period but massive cash flow issues occur weekly, it’s either a capital need or there’s not enough time set in place to explore the options.
Secondarily, if adjustments could happen to fix whatever could help this situation, estimate how much speeding action could help (collecting A/R three days sooner versus paying A/P ten days sooner). If smaller adjustments prevent any gaps, but still create gaps, they’re effectively minimized versus when nothing can change.
Thirdly, time is critical because once adjustments get made to improve cash flow management from within, companies need either time or resources; usually improvements made with cash flow make sense within 30-60 days after implemented, which isn’t much time if financing ideas could add value immediately upon implementation.
Lastly, is maintaining status quo fine? If nothing improves maintaining current operations sounds like death, something must be done of some kind, but what? Deteriorating companies can rarely come back; however, if it’s been hard but stress has been uncomfortable, not life-threatening, it’s worth taking steps first before bringing in additional financing solutions unnecessarily.
What Usually Works Best
Almost always effective improvements can happen before financing, and they should work without borrowing, as owners are unlikely ever comfortable with debt compounding compounded problems with interest.
Tighter invoicing collections/favorable terms better managed/monitoring excess inventory to even out per-unit pricing versus ensuring things are available help all businesses, even those who have no inclination to borrow ever, because if they fix their problems, that makes them independent.
The businesses that have most trouble are those that skirt around the issue entirely, either decide debt isn’t worth their effort, even if they’re ripping themselves off over months due to avoidable circumstances, or prevent timelines from looming, or jump right into financing without addressing available resources with management needs first.
Avoid thinking every financial complication is exactly the same; assess what it is first so each opportunity matches only what’s there instead of arbitrarily combining money management/capital access problems together when they otherwise don’t fit, and shouldn’t fit, for specific problems in question like these.
