What is a Cash Crunch?
A cash crunch is a financial situation companies face when they have a shortage of liquid assets or cash within the business, often leading to difficulties in meeting immediate financial obligations such as payroll, supplier payments, or operational expenses. Essentially, it’s a financial roadblock, where your business does not have enough money on hand to meet its operational needs, affecting your company’s balance sheet and overall cash position.
Understanding What Causes a Cash Crunch
Cash crunches, though often unpredictable, stem from several underlying factors that can disrupt the financial stability of a business. Here are common causes of a cash crunch:
-
Narrow profit margins
-
Poor sales performance
-
Lack of working capital line of credit
-
Absence of emergency cash and funds
-
Unexpectedly high sales volume
-
Too many overdue accounts
-
Insufficient workforce to meet demand
-
Decline in employee efficiency and productivity
-
Unfulfilled equipment needs
-
Unexpected demand for material
-
Late payments from large clients
-
Unnecessary inventory
-
Misuse of resources
-
To much time between material requisition and finished product
-
Excessive reliance on short-term debt solutions
-
Prolonged legal processes or increased legal fees
-
Unforeseen global events
-
Workplace accidents or injuries
-
Market, seasonal, and industry changes
Despite the varied causes of cash crunches, these challenges strain your company’s liquidity ratios and hinder its ability to meet financial obligations, sustain operations, and pursue growth opportunities. Effectively addressing these issues is crucial for your business to navigate through cash crunches and maintain its financial resilience.
How to Avoid and Face a Cash Crunch
Over the years, we have helped solve hundreds of cash crunches – and the biggest determinant of success was the amount of time we had until it hit. The more time we had to solve the problem, the better able we were to avoid an upcoming situation. While there are 3 main levers you can pull to impact your cash, the most important thing is to have a forward-looking Cash Flow Forecast that functions as an early warning system.
When working with clients, we recommend that they look ahead 6-8 weeks into the future on a week by week basis. Why weekly? As any business owner knows, not all weeks are created equal. The first and third week of the month are the most expensive because most companies have rent due the first week and payroll usually falls in the 1st and 3rd weeks. And if the uneven outflows weren’t enough, revenue never seems to match it. Clients rarely care when an invoice is due – they always seem to believe they have until the end of the month to pay. Even if your policy is net 10 or net 15. And when clients get to the end of the month, they start that game they play of “which bills really needs to be paid”. What this means for you is three things:
-
1Expenses are predicable
-
2Income is estimable
-
3Mismatch is inevitable
Because of these three factors, creating a cash flow forecast that will tell you as far in advance as possible when you might have a cash crunch is crucial.
Once you have identified an upcoming cash crunch, you have options to help you deal with the looming problem. Your financing options depend on how much you can borrow, the interest rate, any fees, and the qualifications. But, here is a checklist to help you walk through the problem to find the right solution for your company.
Credit
- Credit Cards – While credit cards are one of the most expensive options when trying to finance a cash crunch, most people have them and they are relatively easy to obtain. If you have available credit, shift expenses to the card to avoid your crunch.
- If you have available credit, you can make a lower payment on your credit card to ensure essential charges won’t be declined.
- If you have limited credit, you can ask to have your credit limit raised
- Although getting new credit isn’t as easy as it used to be, it is fast. When you apply for most cards, you get an immediate answer. Many companies will even give you a temporary number to make charges until your permanent card arrives in a week which you can use to ensure essential charges won’t be declined.
- Line of Credit – At Cathcap, we believe every company should have a line of credit, whether you think you need it or not. Think of it as free insurance. If you have a long relationship with your bank, you can usually get one within a week or so. If you need to shop for a new bank, it might take a little longer. When you go to get your LOC, note these two things:
- If you’re a small business owner, you will probably have to put a personal guarantee on the LOC which means they will ask for all your personal financial information.
- The second thing to note is that banks like to lend money to people who don’t need it. So get a LOC as early as you can, use it to keep it current, and as your business grows, don’t be afraid to ask the bank to increase it.
Expenses
- To weather or avoid an imminent cash crunch, it’s important to evaluate and potentially adjust your expenses. Here are three strategies to consider:
- Cut Expenses: Do not continue to make less money paying for something that isn’t necessary for you to continue operating.
- Move expenses: You can usually shift most bills and expenses to better suite times of the month when you will have more cash on hand, so be sure to map out expenses for next month so you can stay ahead. However, it’s crucial to never touch payroll, as timely payment of wages is vital for maintaining employee morale and compliance with legal obligations!
- Lower Salary/Draw/Distributions: Do you need all the money you planned on taking home? In certain circumstances, especially when faced with a cash crunch, it may be advantageous to leave a portion of your funds in the company. However, this decision should take into consideration the potential impact it could have on your finances and lifestyle. While retaining earnings within the company can boost financial resilience, it’s crucial to ensure that doing so won’t cause too much hardship at home.
Revenue
What can you sell to solve the problem? We have found in most cases, there is usually an additional product or service you can sell your clients that will make a big difference in the profitability of your company. Think about every fast-food place in the world and the question they always ask, “Would you like fries with that?” It worked for them, and it can work for you too.
As you can see, handling a cash crunch is not a one-size-fits-all solution and there are several levers you can pull to help. Often you will find the best solution is a mix of these strategies tailored to your specific circumstances and priorities. For more guidance on navigating these challenges, read our related blog: 7 Questions to Ask When Facing a Cash Crunch, which offers additional strategic questions to help you assess and mitigate cash flow issues effectively.
Effective Cash Crunch Solutions with Cathcap
Enjoyed this read? Stay in the loop with our latest insights and updates –
subscribe to our newsletter now!
Recent Comments