Did your cash buffer evaporate? There are few things in life more worrisome than staring at a business bank account as it approaches zero—or worse—one that’s gone into the red. However, small businesses can often forge a path forward despite this surprisingly common challenge by applying the liquidity crash kit plan below.
Step 1: Activate 48-Hour Financial Emergency Cash Management Protocols
Challenges that arise from a lack of liquidity tend to snowball. For instance, what starts as a momentary cash crisis can quickly turn into checks bouncing, fees, and a loss of trust, all of which have long-term implications for your business. Treat the early stage like a medical emergency. Resist the urge to diagnose or treat the underlying problem. Triage and stop the bleeding first.
Confirm Your Position with a Cash Flow Forecast
Create a 13-week cash flow forecast. Use this to confirm your cash position, where the tight spots sit, and how tight they are. This is akin to performing triage. You don’t need exact amounts. You only need reliable indicators of whether you’re experiencing a shortfall or headed into one, and how large it is.
Pause All Nonessential Spending
Once you’ve confirmed there’s a shortfall, pause all non-essential outgoing payments. This includes items such as subscriptions, discretionary spending, and accounts payable (AP) that are not yet due. Be careful not to cut anything that will impact operations or customer service at this stage. You’ll need to protect revenue-generating operations, as they will help you come out stronger on the other side.
Identify and Prioritize Essential Expenses
Once all nonessential spending is paused, you should have a list of expenses that need to be covered, but with varying levels of urgency. This will include things like payroll, tax obligations, payments to critical suppliers, and possibly even loan payments if there are penalties for late payments.
Go through the list and determine which items should be paid first. Again, the goal here is to preserve operations. Sometimes, there is no “good solution.” You may have to make hard trade-offs, like paying a vital bill late and incurring fees as a result, but if the alternative is not paying your employees and potentially losing your team, the late payment is less likely to have long-term consequences.
Step 2: Explore Short-Term Funding Solutions or Generate Immediate Working Capital
The next step is to get an immediate solution in place to solve your cash flow shortfall. Many people turn to business loans at times like this, but there are a few major issues with the approach.
First, just 37 percent of small businesses that apply for business loans are fully approved, per the latest Small Business Credit Survey. Nearly-three quarters are underfunded or receive no funding at all. Further, it can take weeks or months for an approval to come through and cash to arrive. That’s time you do not have when you’re facing a liquidity crisis.
Secondly, the economy plays a major role in the availability of capital. “Liquidity crises that induce or exacerbate deep recessions, as in 1930 or 2008, are situations in which individuals and firms want to build holdings of liquid assets,” the Federal Reserve Bank of Minneapolis explains. “Heightened risk, or a perception of it, substantially increases demand for these assets. This reduces the supply available for normal transactions, leading to production and employment declines.” In short, if your liquidity crisis is tied to economic uncertainty or a recession, securing funding through traditional financing channels may become all but impossible.
For these reasons, it’s important to identify alternative ways to generate immediate working capital without relying on the traditional banking system.
Request Customer Payments
One of the quickest and most cost-effective ways to improve liquidity is to accelerate customer payments.
- Overdue Payments: If your business is like most, chances are that at least some of your customers have overdue invoices. In all, 43 percent of credit-based business-to-business (B2B) sales are overdue, Atradius reports. Reach out to these customers first to see if you can secure at least a partial payment.
- Invoices Due Now: Next, reach out to any customers with a payment due in the next week or so and ask them to settle up.
- Customers Who May Pay Early: Lastly, if you have good relationships with specific customers or customers with a history of early payments, touch base to see if you can collect on balances that aren’t due yet.
Explore Invoice Factoring
Invoice factoring is another method to accelerate payment on B2B invoices, but instead of collecting from your customer, you’ll sell your invoices to a third party called an invoice factoring company, accounts receivable factoring company, or factor. The factor then provides you with most of their value upfront, collects payment from your customer when the invoice is due, and sends you the residual, minus a small fee, after. This tends to be more accessible than traditional lending options because approval is largely contingent upon the payment histories of your customers rather than your credit score.
When you work with Charter Capital, you’re in control of which invoices you factor and when you factor them, and we can provide up to 98 percent of an invoice’s value on the day you submit it.
In addition to receiving immediate capital, one of the key advantages of small business factoring is that it doesn’t add debt to your balance sheet, as the balance is cleared when your customer pays their invoice. Because of its speed and ability to provide debt-free funding, it can be used for emergency funding and also as a cash flow management tool.
It’s also worth noting that some factors, like Charter Capital, offer specialized support for specific industries. For instance, those in trucking and freight services may qualify for fuel cards and fuel advances (offer not available in California). This can help maximize your working capital and keep more money in your pocket.
Evaluate Working Capital Loans and Lines of Credit
If your business is well-established and has strong credit, you may also qualify for short-term financing options like working capital loans and lines of credit. Working capital loans are paid out like typical term loans in a single lump sum. You repay the balance in installments with interest and sometimes fees, although the payment schedule is typically accelerated. Conversely, lines of credit work more like credit cards, where you can continue to draw from the account up to your maximum. Funds become available again as the balance is paid back. In most cases, monthly payments are required that cover the interest, fees, and at least some of the principal balance.
Be Mindful of Online Lending Options
There is also a plethora of online lenders that specialize in providing funding for credit-challenged companies. Be especially mindful when exploring these options, as they may have annualized percentage rates (APRs) that stretch into the thousands or engage in predatory lending practices such as obscuring the true cost of funding. While they may be able to provide you with fast cash, they are also well known for tying businesses into a debt spiral that’s hard to get out of once the cash flow crisis ends.
Liquidate Nonessential Assets if Necessary
Take a look around to see if you have any excess inventory or surplus equipment. Items that are not in use can often be sold to provide your business with the liquidity it requires today.
Step 3: Stabilize Business Operations and Initiate Operational Cash Control Processes
Once you’ve secured the cash needed to address the immediate crisis, take additional steps to stabilize your core operations.
Protect Customer-Facing Operations First
It may be tempting to make cuts across the board, but it’s important to be strategic about what’s being cut. For instance, if something directly impacts your ability to serve customers or the quality of service, think twice before you reduce your investment, as these aspects directly influence your recovery and the strength of your business post-crisis. Many businesses also reduce marketing investments during this time, but this often negatively impacts revenue and business strength, too.
Negotiate with Vendors Before Missing Payments
If your current situation will put you behind on vendor payments, be sure to reach out to them before a payment is missed. You may be able to secure an extension, negotiate a discount, or lock in special terms that make it easier to pay.
Reduce Operational Spending Temporarily
Explore avenues to reduce your operational spending without negatively impacting your business in the long run.
- Reduce Shifts: If doing so doesn’t impact output or quality of service, try to reduce shifts or total hours worked by your team.
- Delay Purchasing: Hold off on ordering supplies until they’re absolutely necessary.
- Postpone Expansion Spending: Avoid straining your business with growth whenever possible. If you’ve been planning any kind of expansion initiative, evaluate whether it makes sense to wait until your business is more stable.
- Outsource Noncore Tasks: Outsourcing may allow you to save money or free up resources for essential operations. Start by exploring options that are already available to you. For instance, if you’re factoring, the collections process is taken care of for you.
Step 4: Evaluate Your Business Liquidity Strategy and Understand the Root Causes of Your Crisis
As you move out of the cash crisis management phase, do a post-mortem to understand what triggered your specific issues and make addressing them a priority. Each business is different, but cash flow issues tend to fall into a few specific categories.
Limited Reserves
Most businesses will need to tap into a liquidity crash kit at some point, simply because few have adequate reserves on hand. In fact, 39 percent of small businesses cannot cover one month of expenses in an emergency, The Kaplan Group reports. Moreover, 23 percent say they expect their reserves to shrink in the next year.
Poor Cash Flow Forecasting
Many businesses don’t forecast their cash flow at all or don’t make it part of their regular processes. Without it, it’s nearly impossible to predict when a cash flow crisis will hit.
Customer Payment Delays
When customers pay slowly or not at all, it’s harder to keep up with expenses.
Rapid Growth
Expenses tend to increase as a business grows. However, the increased outflows usually hit long before revenue does, increasing cash flow strain.
Seasonality
Liquidity is limited during slower seasons, often leaving little room for anything beyond base overhead expenses. You’re also likely to see increased strain as you ramp up for a peak season.
Unexpected Expenses
Anything from the upfront costs needed to accept a large order or new customer to equipment repairs and purchases can strain liquidity.
Customer Concentration Issues
When one customer or a small group of customers accounts for a disproportionate share of your revenue, any shift in how they order or pay will ripple through your entire business.
Overreliance on Debt Instruments
Adding to these challenges, 86 percent of small businesses use financing regularly, according to the latest Small Business Credit Survey. That’s not necessarily an issue if the debt allows you to grow and strengthen your business, but far too many owners get trapped in debt this way. Not surprisingly, 33 percent of small businesses report having difficulties making debt or interest payments.
Step 5: Try to Ensure You Never Need Cash Crisis Management Again
The harsh reality is that, if you’re in an industry with thin margins and long payment cycles, such as trucking, staffing, manufacturing, oil and gas services, professional services, or security, liquidity will likely always be a concern when you’re still in the small and medium-sized enterprise (SME) stage. However, you can take steps to minimize the likelihood of facing a liquidity crisis and the impact one has if it’s unavoidable.
Know the Difference Between a Zero Cash Buffer Plan vs. Zero-Based Budgeting
There’s an accounting philosophy known as zero-based budgeting. The idea behind it is that every dollar receives a job, so that, at the end of the month, every dollar goes to something, such as a planned expense, debt payments, or savings, and no surplus is left over.
The challenge here is that the name sometimes leaves the impression that you’re operating without a cash buffer. This isn’t true. In the core philosophy, your savings are treated like an expense until you have a sufficient cash reserve.
Build a Cash Cushion and Emergency Reserves
Regardless of whether you use zero-based budgeting or not, it’s essential to build a cash cushion and emergency reserves. Treat them like a bill that you pay every week, bi-weekly, or monthly until you reach your goal.
- Cash Cushion: A cash cushion is a small buffer that can help you keep things moving when cash flow is tight. It’s generally recommended that small businesses set aside one or two months of expenses for this purpose. This can be kept in your main checking account, as it should be readily available when needed.
- Emergency Reserves: On the other hand, emergency reserves serve a separate function. They’re there for more catastrophic events, such as a major drop in business, closure, or loss of a major piece of equipment. Your reserves should be kept separate from your spendable funds. It’s generally recommended to set aside three to six months of expenses in your emergency reserve account.
Maintain a Rolling 13-Week Cash Flow Forecast
In step one, we talked about building a 13-week cash flow forecast. Continue building on that. Update it every week so that you always have a view of the next 13 weeks, and review the accuracy of your predictions. If your liquidity was not as expected in the most recent week, find out why and adjust predictions accordingly.
You can also stress-test your forecast. Also referred to as scenario planning, this involves identifying different scenarios that could influence your cash flow and measuring their impact. For instance, you might test what happens if your biggest customer pays late or if you need to repair essential equipment.
Forecasting and stress-testing your cash flow will help ensure you’re never caught off guard and allow you to create contingency plans for gaps or worst-case scenarios. That way, you can make informed decisions when you have the time and space to do so without unnecessary stress.
Vet Your Customers
Run credit checks on your customers before extending trade credit. Establish requirements and limits based on your findings to minimize the likelihood of late payments and non-payment. Note that if you’re working with a factoring company, they will typically take care of this step for you.
You can also explore non-recourse factoring if you’re worried about non-payment. Under this model, the factoring company absorbs the loss if your customer doesn’t pay for specific reasons, such as insolvency.
Monitor Receivables Aging Weekly
Keep an eye on your receivables and establish strong collections processes that minimize the likelihood of delayed payments. This will keep your cash inflows stronger, so liquidity issues are less likely to emerge.
Diversify Your Revenue Streams
Diversify your customer base, so you’re not dependent on one customer or a small portion of customers. Explore other ways to generate revenue, such as additional products or services and subscriptions. This will provide some insulation if your primary revenue stream is reduced.
Plan Growth Mindfully
Growth strains cash flow. Whenever possible, time expansion wisely and ensure you can maintain stable operations and strong service while you scale.
Find Flexible Financing or Working Capital Options Before a Crisis Develops
When you’re under pressure to find a quick solution, you may be tempted to choose a funding solution that doesn’t serve your long-term needs. Moreover, funding is typically quicker when you’re already established with a provider before you require a working capital injection.
Prep Your Liquidity Crash Kit with Charter Capital
As America’s leading factoring company for over 25 years, Charter Capital makes factoring simple with high advances and competitive rates. We also make it easy for you to factor when it makes the most sense for your business. We don’t require long-term contracts, and you can have the flexibility to factor when it suits you. Whether you require fast funding now or want to be prepared for future needs, we can help. Request a no-obligation rate quote to get started.
DISCLAIMER: This article is not intended to provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
