Cash-flow Problems: Definition, Causes & Methods (2024)

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What is meant by cash flow problems?

Problems with cash flow are very common among businesses.

Cash flow refers to the movement of money. The term describes money that comes into the business and the money that leaves the business.

Cash flow problems occur when the net cash flow in a business is negative. This means that there is more cash outflow than inflow, i.e. more money leaving than coming into the business). This occurs when a business spends more money than it receives.

Effects of cash flow problems

Cash flow problems should be taken seriously and never neglected, as positive cash flow allows businesses to retain cash and spend when needed or wanted. If cash flow is negative, a business should refrain from spending.

Some common effects of cash flow problems are:

• Late or unpaid debts. Businesses that struggle with cash flow might be unable to pay their debts as they become due.

• Inability to pay suppliers. Negative cash flow might make it impossible for a company to pay for raw materials sourced from suppliers.

• Inability to pay staff wages. Firms that do not have enough cash inflows may be unable to pay their employees.

• Inability to buy inventory. Lack of cash may prevent companies from buying inventory and as a result, stop their operations.

Causes of cash flow problems

Firms can experience cash flow problems for a number of reasons. These may include:

• Poor management

• Making a loss

• Offering customers too long to pay.

Cash Flow Problems: Poor management

Although it seems to be something that can be avoided, cash flow problems in many businesses are simply caused by poor management. This is because sometimes managers are simply unaware of the importance of cash flow management and thus do not plan it carefully.

Poor cash flow management can occur with both small and large businesses. However, it is more likely to happen in smaller firms that tend not to employ financial managers. Bigger companies also tend to neglect cash flow management when making financial decisions, as sometimes managers do not think about the influence they might have on a business’s cash flow position.

Cash Flow Problems: Making a loss

Sometimes businesses experience hard times and do not make any profit at all. They make a loss, which is when over a period of time costs of production are greater than revenues.

Although making a loss does not necessarily have to mean that a business’s cash flow is negative, it typically leads to running out of cash. The business is still spending money to operate, but it isn't earning enough money to cover its expenses.

Cash Flow Problems: Allowing customers to take too long to pay

Many companies allow customers to buy products on credit or in instalments. In doing so, they allow them to pay later and deny themselves inflows of cash.

Customers may often wait a week, month, year, or even longer to pay. If the time customers take to pay is too long, a business is likely to experience cash flow problems. In spite of making transactions and spending money on the production of certain goods or services, the business does not receive any money.

Methods of solving cash flow problems

Depending on the causes of cash flow problems and the business circ*mstances, managers can find the right solution to the problems faced by the business.

Some of the solutions that businesses can implement to resolve cash flow problems include (see Figure 2 below):

• Rescheduling payments. When experiencing cash flow problems, a business can try rescheduling payments. In doing so, it can try talking to its suppliers or other parties to whom it owes money and ask to postpone payments.

• Using overdrafts. An overdraft is a short-term flexible loan a business can use whenever it needs. It is a quick and easy way of gaining money that provides an immediate inflow of cash.

• Cutting costs. When faced with cash flow problems, a firm can try to cut its costs to reduce the outflow of cash. It can, for example, try to find alternatives by using cheaper sources of raw materials or fuel.

• Finding new sources of cash inflows. Some businesses might be able to come up with initiatives that will allow them to earn more money and generate extra inflows of cash.

Cash flow forecast

Forecasting cash flow can help a business understand its cash flow and prepare for potential problems in regard to this.

Cash flow forecast refers to the estimates of a company's future cash flow.

As a cash flow forecast allows a business to estimate its future cash flow, it might be able to predict future cash flow problems as well. Having estimated how much money will flow in and how much will flow out of the business, managers can determine whether the cash flow will be positive or negative and why. If the cash flow is expected to be negative, they will be able to take action to prevent possible cash flow problems in the future.

Although cash flow problems are a common issue for many businesses, they should never be neglected. Managers should always analyse the causes of cash flow problems and find solutions to avoid their effects.

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