How to Spot Cash Flow Problems and Fix Them

Struggling with your cash flow? You’re not alone. An estimated 60% of business owners have cash flow problems. 

The truth is that the majority of business owners will face this dilemma at some point. It’s how you react and adapt that matters. 

Knowing the early warning signs of cash flow issues is a great place to start, but taking action to fix the problem before it escalates is key. Let’s explore these warning signs and the strategies you can use to maintain healthy cash flow.

Early Warning Signs of Cash Flow Problems

In most cases, cash flow problems don’t appear out of nowhere. If you know what to look for, you can spot the early warning signs and take action before they become a serious problem.

Here’s what to be on the lookout for:

Increasing Cash Conversion Cycle

A short cash conversion cycle is a sign of healthy cash flow. It means you’re moving inventory and collecting customer payments faster.

If you notice that the length of your cycle is increasing, this is a sign that cash flow trouble may be ahead. It means that:

• Cash is being tied up in inventory and receivables for longer periods of time
• Clients or customers aren’t paying on time
• Your working capital needs are growing
• You’re paying suppliers faster but collecting payments slower

If you’re noticing that your cash conversion cycle is increasing, it’s time to take action before your cash flow depletes. 

Growing Accounts Payable A/P Aging

When A/P grows, it can be a good thing for cash flow health if it’s strategic. But it can also be a warning sign of cash flow problems if you’re not intentionally extending payment terms.

Growing A/P aging can mean you’re unable to pay vendors, rather than simply extending your payment terms

If you’re unable to make payments due to cash flow issues, this problem will only grow over time if left unaddressed. 

You may lose early payment discounts, or suppliers may even choose to raise their prices to compensate for payment risk.

Rising Days Sales Outstanding (DSO)

DSO measures the average number of days it takes to collect payments after making a sale. Rising DSO indicates that you’re collecting payments slower, which is bad news for your cash flow.

If your DSO is increasing, it means that: 

• Your cash is being tied up for longer. For example, if your DSO rises from 30 to 45 days, you’re waiting an additional 15 days for each sale to turn into cash. That’s cash you could have been using to pay bills or invest in growth.
• Your working capital needs will grow. No matter what, your business has bills to pay and employees to compensate. A higher DSO may mean that you need to borrow money or rely on credit to bridge the gap. Financing costs will eat into your profits.

If customers are taking longer to pay, this is a sign that it’s time to take action to avoid future cash flow problems.

How to Fix Cash Flow Problems Before They Escalate

Spotting the early warning signs is just the first step. To prevent cash flow problems from escalating, you need to take action.

Here’s what to do:

Use Cash Flow Forecasting to Predict Problems and Take Action Early On

One of the best things you can do to protect and improve your cash flow is to start forecasting.

Running 13-week rolling forecasts can help you spot cash shortfalls ahead of time, so you can take action early on and prevent them from happening in the first place.

Plus, forecasting can help you see the impact of large upcoming expenses like equipment purchases or tax payments. 

Rolling forecasts give you ongoing visibility, so you can make adjustments as needed.

Monitor Key Performance Indicators (KPIs) and Make Adjustments as Needed

Like forecasting, monitoring critical key performance indicators, or KPIs, can help you take a proactive approach to cash flow management. 

One of the biggest advantages of KPI monitoring is that it gives you specific targets for improvement. KPIs tell you exactly what’s causing the problem, so you can make strategic and effective changes.

For cash flow purposes, consider tracking your:

• Days sales outstanding (DSO) to ensure customers are paying in a timely manner
• Days inventory outstanding to measure how long inventory is sitting before selling.
• Operating cash flow margin to keep tabs on your operating cash flow as a % of revenue.
• Cash conversion cycle to understand the total number of days between cash investment and collection.

Send Invoices Promptly to Avoid Delays

The quicker you invoice customers, the quicker you’ll be paid. Make sure you’re sending out invoices as soon as products or services are delivered.

Consider using automation and invoice management tools to make this process as simple and streamlined as possible. 

Collect on Overdue Invoices and Implement Late Fees

Are you being proactive about collecting on overdue invoices? If not, it’s time to start. Reach out to customers who are behind on their invoices and offer solutions to get paid as soon as possible.

Consider updating your payment terms to include late fees on past due invoices.

The Takeaway

Cash flow problems can easily sneak up on you if you don’t know how to spot the early warning signs. By following the approach above, you’ll maintain visibility on your cash flow throughout the year and can take steps to change course before the issue escalates.To learn more about cash flow management or how we can help you with your accounting needs, schedule a consultation now!