Your company is doing great. Sales are increasing phenomenally, profits are strong and more new customers are calling every day. Yet you suddenly find you can’t pay your bills.
What has gone wrong?
By focusing on sales growth, you may have ignored the signs of a mounting cash flow problem. Profits may only be on paper. You may not have collected from customers yet, but you have incurred the costs—and your creditors are knocking on the door.
This scenario can happen when you have a product that requires you to pay for the costs of production up front, such as with a manufacturing company. Growth is desirable, but if it occurs too quickly there may not be may not be enough cash to meet commitments.
For example, let’s say you need to manufacture 10,000 widgets at a cost of $4.00 each. You will sell them for $10.00 each and net a nice profit. Getting these widgets to the market will require $40,000 up front to manufacture them. Unless you can get credit, you would need $40,000 to pay your production costs.
Now suppose your widgets increased in popularity and sales suddenly rose to 50,000 widgets. Your outlay of cash to build the widgets would rise from $40,000 to $200,000.
If you have enough credit to borrow that much money, then fine. But if you can’t find the credit, you probably have to find other sources of funding, from loans to equity investments to factoring. And the challenge is that raising funding is not easy. If you are facing this type of situation, below are two tips to manage production costs.
Tips to Manage Production Costs
Create Financial Projections
And make sure they’re complete with an income statement, balance sheet, and cash flow statement.
Of particular importance is your cash flow statement. Because even though your income statement may show lots of profits, you need to make sure you don’t run out of cash.
Estimate different levels of sales and the amount of cash shortfalls you might have at each level.
Seek Funding Early
Raising funding for your business is hard and it takes time. If you are too desperate for funding, you are at a terrible negotiating disadvantage.
For example, if raising $100,000 dictates the life or death of your company, and an equity investor says they’ll only give you the money for an exorbitant amount of equity in your company, what will you do?
By starting early, you won’t put yourself in such a position.
In addition, get creative with your funding options. Sure, you should seek out traditional funding like credit cards, bank loans and angel investors. But consider new, more creative funding alternatives, such as giving customers small discounts when they pay all or part of their invoices up front, or getting unique payment terms from your suppliers.
When you are getting lots of sales from your customers, it’s a good thing. But it doesn’t mean that success is guaranteed, as cash flow (and lack thereof) can literally bankrupt you.
So plan ahead and raise the funding you need to ensure you can effectively grow your business.
Production Costs Photo via Shutterstock
Such a useful piece of info Dave, this is a really big problem for the businessmen. Not only the large biz owners face this problem but small biz owners like shopkeepers mostly face these type of problems and I’ve personally experienced this type of situation, money is keep coming but at the end of the month you can’t even pay your utility bills. Thanks for the tips.
Awesome tips, Dave. Thanks for sharing with us.
Many companies face cash flow problems at one point or another from fast growth, slow paying customers or a business slowdown. It is important to have reliable financing in place to weather the ups and downs of being in business. Dave Lavinsky mentioned loans, equity and customer discounts as sources of financing but there are more options: Alternative lenders, asset based or factors provide working capital by purchasing your receivables at a discount (factoring) and some factors also provide purchase order financing (called PO financing) for manufacturers and distributors.
Purchase order financing is a great financing product for companies who need to pay suppliers upfront but need to wait 30, 60 or 90 days for payment from their customers. This creates a cash flow crunch. Purchase order financing works as follows: A factor will post a guaranty of payment to a supplier in the form of letter of credit or irrevocable instruction letter to pay the supplier upon shipment to the buyer. It is important to remember that a letter of credit is very popular when the goods are sourced internationally but it is still a simple form of payment for domestic production as well.
Once goods are shipped to your customer, the factor will then purchase the receivable due from your customer. This seamless combination of purchase order financing and factoring provides payment to suppliers upfront and allows you to take advantage of discounts for early payment. It also frees you from the worry of waiting for cash receipts from slow paying customers.
[Edited by Editor]