I've Got a Cash Flow Problem

Frequently a client reaches out to me because they have "cash flow problems".  It is one of my least favorite issues to deal with because it sometimes involves helping a client see what they don't want to see.

Let me give you an analogy first.  A guy has a cough, so he goes to the doctor and says "I've got a chest cold.  Can you give me something for it?"  The doctor says "sure, but let me listen and give you a couple of tests."

The doctor sees some areas of concern.  It turns out the guy has a bad case of pneumonia--much more serious than a chest cold.  The diagnosis is different than what the patient was thinking.  There are treatment options, but they are more severe than what the patient was expecting.  

The key to a successful treatment for this patient was a proper diagnosis.

When I hear someone tell me they have a cash flow problem, my first thought is to make sure that's the proper diagnosis.  It could be something different, and often times worse.

Some business owners define a cash flow problem as simply not having enough money for what they want to do.  That's not right.  That is far too broad a definition.

Cash Flow Problem.  The real definition is this:  When cash outflow temporarily exceeds cash inflow because of practical or timing issues, you have a cash flow problem.  Here's a common example.  Let's say you are a manufacturer that makes washing machines.  You come out with a new model that is very popular.  Home Depot places an order with you that's twice the size of any order they've ever placed or you've ever gotten.  (all of this is good, right?)

The Home Depot order is going to take you 3 months to manufacture.  Home Depot usually pays you 30 days after you deliver the washing machines.  Here's where the problem comes in.  You've got to buy all of the materials and pay people to do all the work before you get paid.  It is such a big order that you don't have enough money to do it.  You'll be fine after Home Depot pays you, but until then, you've got a cash flow problem.  You've got to arrange some credit or different payment terms with Home Depot in order to manage the order.  

Cash flow issues are common in many industries.  Probably the most common are the construction industry, where contractors build something expensive over a long period of time. And farming, where the farmer puts all of his money into his crops before he's able to deliver anything.

A cash flow problem is a problem, but it is often a good kind of problem to have.  It means that business is good--often times growing--and that more cash is needed to help the business grow.  It is challenging, but you welcome more business like this.

Some people are proud to have a cash flow problem.  They feel like they are being successful in growing the business.  This pride can be very dangerous, because if they don't really have a cash flow problem, their pride can keep them from identifying much more serious issues.  

I've had people say to me:  "Joe, I've got a cash flow problem."  After I look at their situation, I realize that they don't.  They've actually got a cash shortage problem.  The outward symptoms appear the same (just like the doctor's patient who had the cough), but the cause is different.  

Usually a cash shortage problem is because of one of the issues below:

1.  Pricing or Cost Problem:  When you under-price your product and simply don't sell it for enough money, your underlying issue is a pricing or cost problem.  You don't want more business like this, because the more you get, the more you will lose.

How to price things is tricky.  There are lots of considerations.  As a result, under-pricing happens to every company on occasion.  The effective business owner understands this, and is always keeping an eye on costs and pricing.  They understand their costs and they adjust quickly.

On the other hand, the business owner who mis-identifies a pricing problem with a cash flow problem is in for a world of trouble.  You'd be surprised at the number of business owners who chronically struggle to understand their costs.  Therefore, the chronically under-price.  If they don't diagnose this issue properly, they tend to repeat their problem over and over and over.

Overspending Problem:  Another thing I've seen is a business owner thinking they have a cash flow problem when what they've really got is an overspending problem.  They will get a big job and buy a new truck, or new tools, or give themselves a bonus.  Whatever.

You've heard the expression "the money is burning a hole in his pocket".  It's a criticism of someone who just can't seem to hold on to money.  They just have to spend it.  There are business owners who are this way.  I've seen it more than I'd like to admit.  Calculated financial discipline is critical for the business owner.

Undercapitalization Problem:  Sometimes a business owner simply doesn't keep a proper amount of ready cash in their business.  Unexpected expenses always happen.  If a small or mid-sized unexpected expense causes a cash shortage, the amount of ready cash in the bank account may need to be re-evaluated.

Sometimes an undercapitalization problem is just a leftover habit from when the business was smaller.  If properly diagnosed, the fix may not be instant, but working toward the solution can begin right away.

This blog's bottom line is this:  For success in business, cash shortages have to have a proper diagnosis.  If properly diagnosed, they can be properly treated.