Is Cash Flow Your Biggest Challenge?

A recent Federal Reserve Report (March 2016) on cfSmall Business Credit caught my eye. The period covered by the report was between Q3 2014 and Q3 2015 and was referred to as 2015. The reason this report caught my attention is that it listed cash flow as the single biggest challenge identified by small business owners.

Even though financing success improved during 2015, half of the firms reported financing shortfalls. The report defined a shortfall where a firm was approved for less than the amount requested. Micro businesses and startups reported an even higher (63% and 58% respectively) unmet financing need.

Why is this important?
The financial viability of small businesses affects employment and growth of local and regional economies. The financial health of small businesses is a key indicator of the strength of local economies which ultimately contribute to the strength or weakness of the national economy through employment levels and decisions to invest in capital improvements.

Financing Strategy
The significance of a large number of small companies experiencing a financing shortfall, highlights the difficulty in cash flow management. The firms involved in the survey pursued financing measures to ease current period cash needs due to business fluctuations or to support business growth where major investments in people, resources and inventory would be made in advance of new business.

Small business owners take credit financing seriously, as over half of them used personal assets or guarantees to secure their financing. Consequently, the amount of debt carried by these companies is relatively small to reduce exposure to their personal assets.

Despite improved profitability over 2014, only 50% of applicant firms received all of the credit they applied for. The primary reason for growing firms to be approved for less than they requested was insufficient credit history (evidence the business will honor the payment terms) and collateral (sufficient assets or guarantees pledge as security for repayment of the requested loan amount).

Debt Aversion
It was interesting to see that 25% of the firms that did not apply for financing stated that they did not want to take on debt. This also included those firms that were growing and were adopting an internal strategy to finance growth. The primary reason for other firms not applying for financing was lower satisfaction levels due to high interest rates and unfavorable repayment terms.

Companies had greater success in securing financing from smaller banks and had greater satisfaction in their loan experience. Those applying for financing with online financing or large banks had less satisfaction with their loan experience. Transparency issues (loan loopholes, buried fees) were present in 31% of the credit applications and the firms involved were dissatisfied with their experience.

Business Challenges
The small businesses surveyed (3,000) ranked their biggest business challenges in the following order from most significant to least.

  1. Cash Flow
  2. Costs of running business
  3. Hiring and/or retaining qualified staff
  4. Revenue/Sales
  5. Government regulations
  6. Taxes
  7. Credit Availability

Companies that were growing (800), slightly modified this list with Hiring and/or retaining staff as number 1, Credit Availability as number 4 and Revenue/Sales as number 7. Cash Flow was the top one or two business challenge in this business category.

Why is Cash Flow a Challenge for Small Businesses?
Only 5% of the businesses surveyed had more than 50 employees. Consequently, the other 95% were smaller with 21% having 10 to 49 employees and the rest (74%) had 9 or less employees.

You would expect that managing cash flow for a business with 9 or fewer employees would be very easy. However, businesses that small are subject to a number of variables that affect cash flow management:

  • Under developed business systems and practices.
  • Key people over worked to keep the doors open and cash management is down the list of priorities.
  • Vulnerability to economic fluctuations and delays in payments from customers.
  • Insufficient information about the purpose and direction of the business to convince lenders to approve a loan.
  • Suppliers unwilling to extend credit terms thereby reducing or preventing the building of a credit history necessary to get a loan.
  • Insufficient assets or personal wealth of key people to serve as collateral.

If the business generates enough cash to avoid bank financing then managing cash flow is a matter of setting up the process and discipline to monitor the current and future cash position of the business. A business in this enviable state has the ability to finance their growth and cash needs internally and may not involve a bank beyond having a line of credit for short-term use (i.e. cover a third pay period in the month).

Unfortunately, many businesses are not in the position to generate sufficient cash to meet period needs and will need to pursue external financing. This should not come as a surprise and should be part of the initial business strategy of the company to prepare their business practices and relationships with the expectation of applying for external financing at some point in time.

Seeking a loan should not be an impromptu or last minute crisis exercise where you have to find a bank that can cover your operating expenses through the end of the month. Here are a few steps that should be part of your cash management strategy:

  1. A bank should have already been selected.
  2. Discussions regarding financing should have occurred some time before any cash needs are required.
  3. Understand what the bank would need to approve a financing relationship and to have them even review draft business documents on a what-if basis to get their feedback well in advance of applying for a loan.
  4. Establish an on-going relationship with the bank decision makers so that you are aware of any changes they may have in their business that may affect their loan decisions.

Managing cash flow successfully is a critical part of leading your business. For those business leaders who are fortunate to be in a position where they can generate cash internally, they will most likely avoid any debt obligations but are advised to have a banking relationship as a backup.

If external financing is a necessary part of your business, then it needs to be a key strategy of your business from the beginning.

Research your credit needs to be well prepared for future financing needs so that you are well prepared when the need comes so that your credit needs are fully met. 

Additional Resources:
Win-Win Banking Relationships
Is Your Business Undercapitalized?
Should Your Business Produce a Profit?
Cash Flow: It’s Dynamic, Not Static

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