Matching the changes in your business’s income with outgoing expenses makes a healthy cash flow. However, when your business spendings outstrip earnings, it’ll cause cash flow gaps, also called negative cash flow.
Many new companies and small and medium-sized enterprises (SMEs) fail because of negative cash flow. It’s their top risk factor and reason for failing, causing 82% of them to shut down.
In this article, we’ll talk about how negative cash flow affects your small business. To understand it, let’s grasp the idea of cash flow first.
What’s Cash Flow?
In simple terms, cash flow is the net balance of cash that comes in and out of your business. It’s recorded on your business’s statement of cash flows. In this cash flow statement, you’ll see that cash is separated into three categories:
- Operations - for your revenue-generating activities
- Financing - for your company’s liabilities, such as debt payments and equity
- Investing - for your company’s asset sale and purchase (if there’s any)
Understanding, monitoring, and managing these three are crucial processes for all businesses of any size and industry. Generally, cash flow affects a company’s ability to grow, and managing helps companies make better strategic and informed business decisions.
Negative vs. Positive Cash Flow
When tracking cash flow, there are times when you have more outgoing than incoming cash or vice versa. Outgoing cash or cash outflow of cash refers to the amount of money your business has to spend regularly. Conversely, incoming cash or cash inflow refers to any amount paid to your business, including customer payments, sale of assets’ profits, and accounts receivable.
If your business has more incoming cash than outgoing cash, then it’s experiencing a positive cash flow. That means it’s bringing in more cash than it’s spending. That's a common sign of a successful business model.
Positive cash flow gives businesses more capital to spend on various costs, not only for day-to-day business operations but also for business growth. These include costs for purchasing better machines, hiring more employees, or getting a second location for a business expansion plan. Overall, the higher inflow, the more chances to reinvest.
In contrast, if your business has a higher outflow than inflow, it’s experiencing a negative cash flow. In other words, it’s operating with a cash deficit. When this happens, you’ll likely pull from your cash reserves to satisfy your business’s expenses instead of improving and growing your business.
For example, your company can’t cover its expenses from sales alone, so it may need more funds from financing and investments to make up the difference. While it’s normal to do so, continuously being unable to earn enough profit to cover business costs will deplete all your cash reserves, which may eventually result in business failure.
What Are the Implications of Negative Cash Flow to Your Small Business?
As stated, running a failing business is a serious implication of a negative cash flow. One of the early signs of this is client payment issues, such as when you’re unable to reconcile accounts receivables and collect overdue invoices. When customers make late payments or don’t pay at all, it doesn’t only impact your company’s ability to operate efficiently but also your ability to pay for your liabilities. Late charges can be another problem then.
On a positive note, negative cash flow isn’t always a bad thing. For example, spending more than earning is common for many start-ups and SMEs. Building a viable business and investing in initial customer outreach may require a lot of initial expenses. Additionally, seeing positive results from these will, most of the time, take time. As a result, start-ups and SMEs tend to have negative cash flow for some time, particularly at the initial stage.
Another implication is expansion. When companies experience constant positive cash flow, many of them will feel comfortable investing in their business’s growth and will likely start expanding. However, this will bring them back to square one: more outgoings due to expansion costs and periods of negative cash flow. While it may sound bad, it’s another sign of a healthy business, as long as their cash flows trend back to positive.
The same happens while purchasing equipment or other assets that will pay off over time. Most of the time, these investments will cost a lot to the point of having negative cash flow for a while, but only until they start helping bring in new revenue.
Business owners want to see positive cash flow from their operations. However, it’s entirely possible and common to operate a business and have a negative cash flow, especially for a growing business. Even well-established companies experience reduced cash within their cash flow from investing in long-term assets such as property and equipment.
Final Thoughts
A negative cash flow is among the primary causes of cash crunch in many new and small businesses. However, it’s an inevitable stage in any business growth. The key to managing it and preventing business failure is to have a solid plan in place.
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