Small business owners are often overloaded with tons of activities revolving around their business, and they have very little time left for managing cash flows or scratching their heads on the company’s finances. On the other hand, mismanaging your company’s funds might lead to the total failure of your business.
Even though you have the brightest of ideas and your company is on a growth ride from the very first day, it is often seen that 80% of businesses, big or small, fail or close down just because they cannot manage their cash flows.
To add to the injury, certain hidden costs or expenses have an adverse impact on the cash flows, which are very tough to manage since they cannot be perceived.1)
Forced Growth
One of my friends who runs a software development company started experimenting with Facebook ADs. In the first month itself, he got good returns on his investment. He immediately increased his AD spend by 5 times, anticipating a 5x growth in sales.
Well, that didn’t happen. He did generate more leads, but not in proportion to the ad spend. He spent more than he earned in that month and ended up screwing his cashflow. He had to take a short-term loan to cover the month’s expenses.
It is a good thing for a company to have a great growth story, but sometimes excessive forced growth can spell doom for the business.
What’s forced growth? It would call for more cash to be paid to the staff, a bigger office to accommodate more people and clients, a rollout of new products, higher than needed AD spend, etc. that would call for greater expenses.
These are effort-oriented tasks that need to be handled rapidly, as the loss of too much cash will severely affect your day-to-day operations. These extended services bring in more revenues, but with revenue comes more cash outflows. Efficiently estimating these cash outages in due course of time can help you prepare for exigencies.
2) Excessive sales spending
As a small business, it is difficult to get new customers, even at the cost of incurring losses. There are two metrics to identify whether your client is bringing you the profit that you anticipated. One of them is the ‘Acquisition Cost’ of the customer, which is the amount spent on gaining one customer.
The other is the "Lifetime Value" of the customer, which is the total revenue generated by a customer over its lifespan. It has to be ensured that the lifetime value is greater than the acquisition cost. In this way, a positive effect is felt on the cash flows of the company.
Overspending on the acquisition cost might lead to gaining a small customer with a very limited return. Many businesses falter on this point as they perceive that the more customers, the greater the profit.
There are a lot of hidden elements to the acquisition cost. For example, the salary of the sales person, the amount spent on his mobile and internet connection, the cost of his seat in the office, his commissions, etc. You need to add up all these indirect costs to correctly calculate the customer acquisition cost.
If you don’t do this, you’ll unknowingly start burning more money than you earn and this will eventually affect your cash flow.
3) Incorrect Profitability Calculation
One of our ProfitBooks customers sells mobile accessories on ecommerce marketplaces. He buys the stuff at a 40% margin from his sources. For example, he buys a headphone at Rs. 600 and sells it at Rs. 1,000. He used to always believe that he was making 30–40% on every sale, considering minor expenses.
But when he prepared his balance sheet at the end of the year, he realised that he had made losses. He did not consider the marketplace commission, transaction fee, shipping cost (which varied for every order), cost of storing the inventory, and most importantly, the cost of returns.
Many a time, businesses feel that there is enough profit from every transaction they enter into. However, businesses of all sizes run into severe cash problems because they have committed too much to overheads.
Sometimes, a healthy, cash-rich company buys a huge office or invests too much in rents, fancy utilities, etc. and treats them as trivial at first.
Nevertheless, when the going gets tough, it becomes difficult for the company to keep up with these excessively committed costs and ends up losing cash rapidly. Thus, a company can become cash-hungry from being cash-rich in a matter of time.
Anticipating these expenses and the consequences thereof is necessary for the well-being of the company. One can only be profitable when there is enough money in the bank account left after paying off all their expenses.
4) Ignoring the Business's Seasonal Nature
This is applicable to some businesses that do not have a year-long operation. These businesses find themselves tremendously cash-rich during their peak seasons and, on the other hand, face difficulty in managing daily cash outflows.
When the cash-rich season begins, it leads to overhead commitments that are difficult to maintain during the off-seasons. Besides, these off-seasons result in discounts and offers, which reduce the margins for the sake of maintaining some level of sales.
There should be enough provisions for these off-seasons in your financial plan. For example, the Diwali and marriage season see a lot of sales in jewellery and clothes.
However, sales decline rapidly for the remainder of the year, resulting in a larger cash outflow. As such, there must be an ample amount set aside for fixed expenses to be incurred.
5) Snoozing Over Overdue Payments or Amounts
Late receipts against your invoices can spell trouble for your business. It may sound trivial, but the fact is, when your customer delays the payments, it will be difficult for you to pay your vendor.
Moreover, if your vendor does not wait for his payments, that would mean you have to pay him off to maintain future credibility. As a result, you will lock up a major chunk of your funds in this working capital, and you will not be able to meet operating expenses easily.
Too much credit can hamper your working capital requirements, and suppliers lose credibility very often since payments come in after approximately 3 months. That means no payments or holding expenses for 3 months, which can severely hamper operations on a large scale.
Learn how to create professional invoices and get paid faster.
6) Improper Management Of Taxes
Tax is a fine for doing well. It sounds funny, but it is true. Taxes are statutory obligations that are obligatory in nature and have to be paid, whether you like it or not. Moreover, it has to be paid whenever it is due.
Whenever you miss the deadlines, it can attract interest and penalties that can influence the cash flow. If there are several defaults at the taxpayers’ end, then the income tax department or the commercial taxes department can come knocking on your door for an audit of operations, again attracting more penalties and interest on penalties. Thus, taxes have to be accounted for, and accurate calculations must be made in the financial plan.
You can seek the help of an expert tax consultant in identifying the approximate amount of tax that you will end up paying next year. It depends on the growth plan of the company anticipated for the forthcoming year and the financial budget presented by the Ministry of Finance at the beginning of the fiscal year.
A sudden change in the tax rate can also affect the cash outflow. It is often seen in the case of service tax, where recently the rates were increased from 12% to 12.36% and then to 15%. Then, after the GST rollout, a lot of items suddenly fell under the 28% tax bracket. Your product or service might have been exempted from tax earlier but may be taxable in the GST regime.
So, it is always wise to plan for such statutory uncertainties. It has a long-lasting impact, and making ample provisions for the year to come will always be beneficial to the company.
7) Failure to Plan Ahead For Divine Acts
This is something which no man has control over. These are totally unexpected and unforeseen expenses, which can seriously damage the cash profile of any company.
A natural disaster can trigger chaos across the country or the geographical zone in which the company operates. One can also lose their entire office following an earthquake.
Your top performer may leave the company at a moment’s notice, or there may be a negative complaint from your most reputed customer. Such items cannot be anticipated in advance and ultimately end up losing business almost instantaneously.
A contingency plan is what one must have to keep himself safe from these mishaps. There is no way one can avoid these, but one can have an emergency fund created to at least maintain the business running with the bare necessities.
The best way to secure yourself from any act of God is with insurance. Most of the top insurance providers have an act of God specifically mentioned in their contracts.
Also read how you can future-proof your business.
8) Neglecting Credit Score
Having a bad credit score can make it difficult for you to secure a small loan when you need it. When you have lost a major chunk of your machinery and it would cost a bomb to replace it, the only option that you have is to get a small loan.
But since your performance has not been stellar in the past, investors might view you as a potential risk and refrain from giving you short-term loans.
In the end, you end up securing your machinery or even personal assets as collateral for the loan, which is a huge risk in the long term. In the
GST regime, every tax payer will be given a GST compliance rating. As a business owner, you must maintain a good rating, which can come in handy in cash crunch situations.
9) The Cost of Poor Hiring
This has hurt us multiple times in the past. We hired 3 sales executives from a reputed company. Their resumes were all adorned with achievements. They asked for a 30% hike, and we agreed. We spent the first month training them. We are hoping that our sales will at least double once these guys become productive.
Nothing happens in the next month. Absolutely no sales from these new hires. We thought they might need some time to adjust themselves and waited for another month. They achieved barely 10% of their sales target. The same thing happened in month #4. Finally,
we decided to let them go.
Did you see what happened here? We ended up losing money in those 4 months on training and remuneration. That badly hurt our cashflow.
Later, we came up with a better hiring process, but the point is that the cost of a bad hire can really make a dent in your cashflow.
10) Other Unexpected Costs
Some costs may appear insignificant at first, but they typically accumulate over time and, when implemented, can be detrimental to the entire company.
These can be insurance coverage, credit card dues, unforeseen employee attrition, permits/licenses, overdue employee benefits, commercial and legal fees, detention charges by the carriers of goods, and much more.
These additional costs cannot be anticipated in advance but may result due to a lack of knowledge or awareness on the part of the owners or managers.
Final Thoughts
Cost is like water and can seep through the smallest of holes. A magnet of sorts attracts expenses and outflows. When you have a proper financial plan that estimates or provides for all kinds of costs, be they exigencies, contingencies, or thought for, it is always beneficial for the company. It helps the owners to be prepared for all kinds of situations and not fall into the trap of working capital overruns.
Some costs can be felt instantaneously given the nature of their source. The above 9 items enumerate how some costs, hidden in nature, can lead to worry-some situations for the owners, which can be safeguarded by keeping ample provision in the books of accounts.
Using a good accounting software can help you stay on top of your income and expenses.
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