Business Cash Flow Falling? Know the Difference Between Financial and Operational Difficulties

Operational cash flow

When your business cash flow is falling, you must determine whether the cause is financial or operational.

It’s important to understand the difference between operational difficulties and financial difficulties and to determine which is the primary source of any downward trend in business cash flow. If your company is encountering financial difficulty or serious operational issues that could quickly lead to financial difficulty, pay attention. There’s a critical difference between the two. An interim CFO may be able to help with a purely financial issue resolution, but a turnaround consultant will be crucial for an operational turnaround (although that consultant may ultimately step in as the CFO or COO or even CEO to take charge of the turnaround).

Rarely are financial difficulties purely financial.

First, very few “financial difficulties” that companies encounter are solely finance-based. Finance-based issues are those that are the result of poor capital structure decisions such as taking on too much debt. That usually involves having EBITDA (earnings before interest, taxes, depreciation and amortization) that can handle the debt service at the time the loan is originated but, due to the general economic environment, loss of a customer, drop in average sales volume, etc., the EBITDA can no longer cover the debt payments. Or the finance-based issue could be due to taking on improperly structured debt – debt with a balloon payment, high interest rates, escalating interest rates or payments. The terms may have seemed fine at the time but are ominous 1, 2, or 3 years later.

Pure finance-based issues are fairly easy to fix (assuming you communicate frankly and regularly with the financing entity/debt provider). Simply sit down with the entity providing the loan and negotiate a restructuring. Request extended terms (an increase from 5 years to 7 years, for example), a lower interest rate for a specified period of time (from a few months to the remainder of the term), or removal of the balloon, to name a few of the options. As long as the underlying fundamentals of the business are the same, the debt provider will generally be amenable to restructuring the loan and hence, improving the business’ cash flow.

Underlying fundamentals changed? —> Operational issues

That last statement is key. If the underlying fundamentals have changed, those are operational issues NOT financial issues. If your company lost a major customer and that customer comprised 20% of sales and 25% of profit, that’s NOT a financing issue. A major customer loss is an operational issue. Obviously, your firm may not be able to make your loan payments but you should have seen the issue in advance. That 20% customer has been that way for how long? Two years? Four years? You should have set up a plan to remove or decrease the risk of the loss of that one customer. Are your receivables taking 60 – 90 days to be paid? Has this been ongoing for years? Usually, it’s not a new development. That would be a finance issue. Usually, companies, especially rapidly growing companies, allow accounts receivables to hang out there for months at a time and this tendency continues for years. Then, when they stop growing so rapidly and the new business can no longer cover the receivables from existing customers or vice versa, the company experiences an almost immediate cash flow shortage.

Another operational issue

Another operational issue is poor customer service or high customer turnover. When business is expanding and new customers are continually coming on board, a business can handle the drop off. But when business drops off, poor service reaps a high net cost on the bottom line.

These are just a few of the myriad operational issues that affect a business and results in financial issues in downturns. If any of this sounds like you, coulda, woulda, shoulda. The past is the past. You can’t change it. Don’t keep beating yourself up. Just ask for help from those that can provide it. Your CFO or an interim CFO, your CPA firm, your board, your banker, a turnaround consultant. Act soon so you can take effective action and successfully turn around your business and improve your cash flow before it’s too late.

If you need assistance, please contact us at The Resourceful CEO. Although we are not turnaround consultants, we can help you quickly identify the issues and either resolve them or help you find someone to step in to resolve them.