Cash flow is a crucial aspect of any business. Cash flow refers to the movement of money in and out of an organisation. Positive cash flow means that a business has more cash coming in than going out, while negative cash flow means that the opposite is true. For this reason, it can be easy to assume that by simply selling more, thus increasing your cash 'inflows', you are ensuring healthy cash flow for your business.
However, the reality is much more complex...
Simply selling more is not always the silver bullet in achieving good cash flow. In fact, there are a number of factors at play that will determine if selling more can improve your cash flow.
The myth of selling more to improve cash flow
A misconception about cash flow is that selling more products or services will automatically improve it. The truth is that increasing your sales does not necessarily translate to an immediate cash flow boost. This is because many customers may pay on credit or require payment terms. Here are some factors to consider when evaluating whether selling more is a viable solution to cash flow issues your business may be experiencing:
Payment terms and credit sales
- Customers may pay for goods or services on credit, which means that the business does not receive cash until a later date. For small businesses, significant delays in cash inflows, such as from a large sale, can have a significant impact on a business's ability to meet its financial obligations and cover expenses, such as paying employees or vendors.
- In some industries, particularly in business-to-business transactions and for service providers, credit sales are common. Businesses need to factor in the cost of extending credit to customers for a period of time when forecasting the impact of sales on their cash flow.
- If a large portion of sales are made on credit, a business may run the risk of cash flow issues if customers do not pay on time or default on their payments.
Furthermore, even with payment terms in place, your customer may pay you late and beyond the agreed terms. Currently, 9 in 10 businesses are typically paid after their agreed invoice due date. If relying solely on sales to improve your cash flow, you risk factoring in cash inflows that may happen later than expected, or potentially not at all of the customer's late payment becomes a bad debt.
To help gain more clarity over when customers will pay you, you can run credit checks to better understand your potential customers' payment habits. This lets you reduce the risk of extending credit to customers who may pay late after a sale has been agreed, and put your cash flow at risk.
In addition, you can enforce your chosen payment terms by using late payment fees to discourage customers from paying you late. On the flip side, you can also encourage customers to pay within the agreed terms by rewarding them for making timely payments, with early payment discounts.
Increased expenses
- Increasing sales volume can lead to higher expenses, which can further strain a business's cash flow. For example, if a business needs to produce more goods or services to meet increased demand, it may need to invest in additional resources such as raw materials, labor, or equipment. These expenses can create a cash flow gap between when the business spends money to produce goods or services and when it receives cash for those products or services.
- If a business is not able to negotiate better pricing or terms with suppliers, increased production costs can further exacerbate cash flow issues.
- Other potential expenses to consider when evaluating the impact of increased sales volume include marketing costs, sales commissions, and delivery expenses.
Sales cycle length
- Not all sales are equal when it comes to cash flow. Some products or services may have a longer sales cycle, which means that it may take longer for a business to receive cash for those sales.
- For example, if a business sells high pricepoint items that require a longer sales process or a more complex purchasing decision, it may take several months or even years for those sales to result in increased cash flow. This can create a significant cash flow gap for the business, especially if it is relying on those sales to fund ongoing operational costs.
- Businesses should evaluate the length of their sales cycle and the associated costs and risks when considering the impact of increased sales volume on cash flow.
Financial management practices
- Businesses that focus solely on increasing sales volume may neglect their financial management practices, which can further exacerbate cash flow issues. Effective financial management involves more than just increasing sales volume; it also includes managing expenses, cash reserves, and debt effectively.
- Businesses should implement sound financial management practices, such as creating and maintaining accurate financial statements, developing cash flow projections, and monitoring key financial metrics, to ensure that they are making informed decisions about their cash flow, and forecasting effectively for upcoming business expenses.
External conditions
Economic conditions have a significant impact on a business's cash flow, with slow payments, reduced demand, and increased competition being common challenges. During economic downturns, businesses face an uphill task to improve their cash flow even if they sell more. According to a survey by the NSBA, 45% of small businesses said they experienced cash flow problems during the Great Recession, and 81% of these businesses cited slow-paying customers as the primary cause.
Increased competition is another factor that can impact cash flow, especially when businesses resort to price reductions to maintain market share. A study by Prisync revealed that 73% of ecommerce businesses experience downward price pressure from their competitors.
Conclusion
In conclusion, selling more products or services is not a guaranteed solution to cash flow issues. While increased sales volume can have a positive impact on cash flow, it is important to consider other factors, such as your payment terms (and how you enforce them), expenses, your sales cycle length, financial management practices, and external conditions.
For more guidance on improving your business' cash flow, visit the resources centre, which contains a wealth of accounts receivables and cash flow best practice guidance.
