How to Avoid and/or Survive a Cash Crunch
No matter how solid your business model, unexpected events can create a cash crunch. Without short-term operating cash, even an otherwise profitable and successful business could find itself in distress. To help you avoid that situation, we'll first look at ways to avoid a cash crunch; then, if in spite of your best efforts you find yourself behind the cash eight ball, we'll provide tips on how to survive and once again thrive.
First, follow the tips provided in the article How to Manage Accounts Receivable . Getting paid on time or better yet, up front is a major component of avoiding a cash crunch when your business is otherwise thriving. If you're struggling to make sales, that is obviously an entirely different problem than managing accounts receivable on sales you have made.
Then, take a look at your basic customer acquisition and growth strategy. If you are taking on new customers and extending credit to those customers before performing thorough credit checks, you may be exposing your company to major financial risk (check out the article Credit Checks for tips on how to perform thorough credit checks on new customers). Also consider whether you should accept a significantly larger than usual order; if processing and fulfilling that order will delay shipments to other customers, payments by those customers may also be delayed, creating a cash flow crunch.
Also keep track of upcoming equipment and supply needs. If you need to purchase new or replacement equipment, for example, the cost of those expenses could outstrip your short-term cash receipts. If that happens, you may need to borrow money to make those purchases. Keep track of inventory needs, and ensure you have adequate cash flow to support upcoming purchases especially if you run a business with seasonal swings in volume and inventory purchasing.
Don't forget to make all tax and benefit payments in a timely manner. Using money accrued for payroll taxes to fund operating expenses is risky at best and could be crippling at worst if you are unable to "repay" those funds before payment is due to the IRS. Your best bet is to keep payroll, benefit, and other funds in accounts separate accounts from normal operating accounts.
Here are ways you can spot a potential cash crunch before it occurs:
- Know your business. If you have seasonal needs whether for more employees, more inventory, or greater expenses and those needs will have to be paid for ahead of receiving payment for goods or services, build up sufficient reserves or get a line of credit in place ahead of time.
- Only take on debt you can handle. If you borrow money, make sure you can afford to make payments based on current operations, not on the potential of future increases in sales and earnings. If the growth you hoped for doesn't occur, you may find it difficult to make payments.
- Keep inventory at a minimum. Money you spend on inventory is cash out until those goods are sold. If you can purchase inventory on credit, great but make sure you have a good sense of your inventory aging and related accounts receivable so you can feel comfortable you will receive payment before you are required to make payment.
What if, despite your best efforts, you find yourself short of cash?
- Talk to your lender. Make contact as soon as possible; the more desperate you are the greater risk you tend to pose to the lender and the lower your chances for approval.
- Increase rapid payment terms. Ask solid customers to pay earlier in return for a larger discount. Sometimes a quick phone call explaining your situation could pay off; some customers will be happy to help you through a crisis, especially if they feel the favor might be returned someday.
- Require payments in advance. If you can't afford to extend more credit, require payment up front. Some customers may balk at the idea, but if taking new orders by extending credit only digs a deeper hole, you may have no choice.
- Cut expenses wherever possible. Just keep in mind the last place you may want to cut is sales.
- Consider barter arrangements. Instead of paying for services, you may be able to provide services in kind to some of your vendors. While you will have to provide the service in return, at least doing so will not require cash.
- Hold accounts payable for a longer period of time. Paying on time is of course your goal, but if you don't have the cash you may have no choice. But before you do:
- Renegotiate with vendors. Call and explain your situation. Try to establish different terms. You can also shop around for other, possibly less expensive, providers.
- Sell inventory, especially slow moving inventory. Even if you sell at reduced prices, you still generate short-term cash flow. However, keep in mind that if you sell at reduced prices to current customers, you should let them know you're holding a special sale and that prices will return to normal levels in the future.
- Sell and lease-back company assets. Say you own manufacturing equipment; you could sell and then lease back that same equipment; in effect it's like taking a loan on the equipment you own.
- Sell unneeded assets. If you don't use it, sell it. While you're at it, try to eliminate your need for external storage facilities by weeding out unused equipment, furnishings, or fixtures.