Four red flags for SMEs when protecting their cash flow

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Illustration of 4 red flags for SME businesses

This article was originally posted in Dynamic Business and written by Wayne Morris, CEO of Fifo Capital.

Cash flow is the lifeblood of small businesses, but it’s tougher than ever for Australian SMEs to protect it.

With more rate hikes predicted, rising inflation and the possibility of a recession piling on the pressure, many small business owners across the country are scrambling to stay financially agile and remain competitive. More than half of Australian small businesses are facing cash flow pressures.

Cash flow issues often simmer just below the surface of a business’s operations. One bad month can leave a business — seemingly all of a sudden — unable to make payments to suppliers, repay loans, and pay bills and wages. The owners of these businesses are often left stunned by what has happened.

Liquidity problems very rarely happen overnight, however; they are usually months or years in the making. The problem is, they can be difficult to spot before it’s too late. That’s why it’s important that business owners stay on the lookout for certain “red flags” that could suggest cash flow issues are coming down the line.

Here are some examples:

Poor customer/supplier creditworthiness

If a business’s customers are mostly other companies, and if the contracts with those customers are large relative to total turnover, credit risk management is a crucial discipline. The unexpected losses brought on by a customer being unable or unwilling to pay — or even going into liquidation — can be devastating for a small business operating on tight margins.

While the benefits of customer credit risk management are relatively obvious, few businesses think about doing risk management in respect of suppliers, too. But checking the financial stability of suppliers can also be crucial for some businesses. If a supplier runs into trouble, they may not be able to fulfil orders or perform services, potentially disrupting a customer’s operations for weeks. Supply chain disruptions are a major cause of cash flow issues.

Before any purchases are made or contracts signed, businesses can check potential customers’ and suppliers’ credit scores through one of the credit bureaus. There are a number of services available online, some of which are very affordable. This small investment could save months’ worth of financial stress.

There are two crucial questions to ask. First — is it too risky to do business with this company? If it seems that there might be some risks, ask the second — is there a way to alter the terms of the contract to mitigate this risk for example, by requiring payment upfront?

Late payments

Customers who make a habit of paying late are the archenemy of cash flow. As unpaid invoices rack up, business owners must borrow or dip into their own pockets to cover expenses. This happens to thousands of Australian businesses every day: one in four Aussie SME owners have had to dip into personal savings to support their business and one in three say they’ve recently been unable to pay themselves because of cash flow pressure. From my experience, late payers would have been to blame in most of these cases.

Implementing direct debits is the easiest way to solve this problem. Unfortunately, this solution isn’t appropriate for every business.

Just like any bad habit, it’s crucial to nip late payments in the bud as soon as possible. Every business with regular customers or customers with long-term contracts — and which is unable to automate debits — should be analysing customers’ payment behaviours and identifying concerning trends.

If manually analysing customer payment habits is too time-consuming, there are systems available to automate the process, including the homegrown, AI-enabled Fifopay.

Businesses should take care not to become late payers themselves. For those with loans or other borrowing facilities, making repayments on timeously is essential to ensure that financing promotes a business’s success rather than hindering it. Defaulting on repayments paired with high interest rates can cause a spiral of debt and repayment fees.

Even businesses without debt should take care to pay on time: dishonouring suppliers’ payment terms can cause an influx of problems as suppliers lose trust and credit spirals.

Variations in sales volumes

If a business has a high degree of seasonality or unpredictability in sales volumes for any other reason, cash flow is harder to manage.

Seasonality is common in certain industries, especially those relating to travel and tourism. Similarly, retail businesses see higher sales around the festive season. Most businesses in these industries have a plan to manage periodic variations in income.

Businesses outside of these industries should also be aware of the possibility of income variability, even if it is not as easy to explain. One suggestion is to plot turnover on graphs over time, comparing it in month-on-month, quarter-on-quarter, and year-on-year terms, and ask what cause-effect patterns can be observed. Does turnover pick up following a marketing campaign or event, or at certain times of the year? Is turnover correlated to economic events?

The more a business understands the factors — both within and outside of its control — that influence its turnover, the easier it becomes to plan discretionary expenditure in a way that does not put pressure on cash flow.

Dodgy invoices

Australian businesses lost more than $23.2 million to scams last year. Small businesses are increasingly vulnerable to the threat of invoice fraud, which can be devastating to cash flow.

As invoice fraud becomes more sophisticated, it is more crucial than ever to implement eInvoicing and other kinds of tech-enabled protection. With myriad digital accounting solutions and fraud detection software available in the market, manually confirming the legitimacy of an invoice and its listed amount is easier than ever.

In the meantime, when reviewing an invoice, businesses should always check:

  • Verification of vendors
  • Branding and logos
  • Company name, address, and contact information
  • Payment information and history

It’s true that it’s getting harder to run a business. With red flags like poor customer or supplier credit, late payments, variations in sales volumes, fraud, and dodgy invoices, it’s no secret that SMEs need all the help they can get.

The good news is there are more tools than ever to help businesses survive and thrive. Taking the time to review cash flow and implement automated systems will ensure SMEs can stay afloat.

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