What Is a Cash Crunch: What Happens When Money Is Tight
As a turnaround professional, I help companies that have fallen behind in their financial obligations to creditors, employees, and other stakeholders. The cash problems a company experiences usually start small but can grow over time to become almost unmanageable. Many of these problems can be avoided with more effective cash management discipline. Learn what a cash crunch is and the five steps business owners should use to survive.
The earlier a company can adopt these, the better its chance of successfully weathering the storm. In other words, these steps help ensure a cash crunch does not become a cash crisis.
What Is a Cash Crunch?
A cash crunch means a business doesn’t have enough money to keep up with operations and needs to change its non-liquid assets into cash. This can mean a lack of funds to buy materials or pay staff and suppliers.
Dealing with a cash flow crunch isn’t necessarily bad; it impacts your business, but it can happen for positive reasons, such as an increase in customers.
It’s crucial to understand a cash crunch does not equate to bankruptcy.
What Causes a Cash Crunch?
A cash crunch can happen for a variety of reasons, both positive and negative. Some are due to poor planning, and some are due to unexpected circumstances. A cash crunch can occur due to:
- A sudden need for increased materials
- Accidents or injuries on the job
- Employees not being productive
- Fluctuations in the market/season
- Low gross margins
- Long legal processes
- Low sales
- Insufficient employees to keep up with demand
- Unmet equipment needs
- Low net margins
- Lack of a working capital line of credit
- No emergency fund
- An excessive gap between material requisition and the finished product
- Too many past-due accounts
- Too many big customers paying late
- Too much focus on short-term debt solutions
- Too much unnecessary inventory
- Unexpected global events
- Unexpected high sales
- Wasted resources
5 Ways to Avoid Cash Crunch
Concerned about running into a cash flow crunch? Here are five ways to avoid this difficult situation.
1. Control and Manage Cash
Managing cash can mean a lot of things, but the following three elements are key:
First, ensure there is discipline around the number and types of ways cash can be spent by the business. Company leaders should limit the number of signatories on their accounts, reduce the number of employees with company credit cards, and be sure oversight exists for processing trade payables. In theory, they should channel all the company’s spending to a few trusted individuals. Nothing should go out the door that the CEO or CFO is unaware of.
Second, it’s essential a company forecast its cash position weekly, including cash receipts and disbursements. All too often, a prospective client in a cash crisis explains that the sudden crunch was unexpected. A cash crisis is always unexpected when the company does not forecast cash! If the company had forecasted cash, it would have had weeks to prepare and mitigate the crisis.
Last, find hidden sources of cash. These might be stale legal retainers that have never been refunded, dormant cash accounts, unclaimed property, collection of tax credits, and so forth. Every business has hidden cash in some form, and it’s usually large enough to fund an entire payroll or two.
2. Find Expense Savings
Companies usually have no problem ramping up cost structures during good times, but squeezing costs out of the business during bad times is rarely as easy. Most businesses in a state of decline assume a slump in sales is temporary and that it just needs to weather the storm. While this can be true in some cases, it’s important to recognize when cost cuts are necessary and how to effectively make them.
Business owners must be quick to respond when expense cuts are necessary. Any delay in making expense cuts will cause a cash crunch. When expense savings include downsizing staff, it’s important the company seeks qualified help to comply with local and federal employment laws.
3. Collect from Customers
Cash is king during a cash crisis. Business leaders should accelerate efforts to collect cash, invoice customers as quickly as possible, offer more generous discounts for timely payments, shorten payment terms, and aggressively collect from past-due customers. Management should hire legal help to protect security interests and/or file bond claims.
For businesses with long standing customer relationships, owners or other leaders with strong connections should get involved with collection activities.
4. Negotiate with Trade Creditors
Keeping communication channels open with vendors is critical. Start early to let vendors know you will pay them later than usual. It is critical to keep their trust so valuable products and services continue. When things get tight, negotiating with them will be easier if you have communicated along the way.
Negotiating with creditors can be a delicate effort, and companies should retain qualified legal counsel to help. With the right help, companies can usually find significant short-term cash savings by restructuring trade payables, lengthening payment terms, receiving debt forgiveness, and/or trading debt for equity.
5. Sell Non-Performing Assets
Just like households, companies accumulate a tremendous amount of stuff over their lifecycles. It’s important for company leaders to take action with slow-moving inventory, non-productive capital assets, and dormant real estate. Companies should also evaluate non-performing divisions, locations, and product lines. The sale of non-performing assets can be a significant source of capital.
Cash is the lifeblood of any business.
How to Avoid a Cash Flow Crunch as a Startup
Are you a startup business owner concerned about a cash crunch as you expand your business? The key to avoiding it is to meticulously plan so you have control over as many variables as possible. Additionally, this method allows you to weather the unexpected easier.
Create and Follow an Accounts Receivable and Payable Calendar
Compile all debts you have, both one-time and monthly debts, and when you have to pay them. It’s important to keep track of when you’re supposed to be paid; that way, you know when to follow up with the other party.
You can’t pay off your debt if you don’t get paid.
Try to Predict the Future
Create a cash flow forecast where you estimate how your cash will come in and out of your business. It won’t be perfect, but it can give an idea of the health of your finances. It’s best to start with weekly or monthly forecasts.
Maintain an Emergency Fund
Before disaster strikes, put money aside for the unexpected. The fund may not be able to circumvent all issues, but it will soften the blow.
Know Your Limits
It’s easy for startups to think and go big, but that leads to periods of cash crunch. Right from the start, know what your limits are and follow them. Only expand when you have the space and money to do so.
Have a Backup Source of Funding
Let’s say you’re experiencing a cash crunch and have run out of money from your emergency fund. The longer you’re without money, the more your business will suffer. This is why you need a backup source such as a loan or a business credit card.
Amplēo Can Help You Avoid Cash Crunches
All the steps above are proven tools successful companies use to manage, preserve, and collect cash. It’s never too late to implement the steps, and the earlier a company can adopt these practices, the more likely it is to survive a cash crunch.
If you aren’t confident in your financial skills or just aren’t sure where to start, Amplēo can help. We have CFOs on hand ready to help you and answer any questions you may have about the financing process.
Contact us to amplify your business’s opportunities today!