Negative cash flow: What is it and how long can a company survive with it?
If you aspire to establish a prosperous company, it is essential to generate more revenue than expenses in the long run. Nonetheless, many business owners face situations where they have to spend more than they earn, resulting in negative cash flow. Negative cash flow is not entirely a bad thing IF you have a plan in place. However, it is crucial to avoid running out of cash altogether. To steer clear of such situations or to enhance your business cash flow, you may want to explore the various funding sources available.
TLDR:
- Negative cash flow is when a business has more outgoing than incoming cash during a specific period.
- It is common for businesses to experience periods of negative cash flow which may be expected in some cases.
- Negative cash flow can pose a significant challenge to a business in the short term and pressure to reduce costs can intensify.
- Operating with negative cash flow isn’t necessarily a bad thing, but it is important to have a plan or strategy.
- You can operate with negative cash flow so long as you have cash reserves or access to small business funding to continue operations.
- To find your cashflow runway, you can calculate your burn rate, which is how quickly you’re losing money.
What is negative cash flow?
Negative cash flow occurs when a small business (or any business really) has more outgoing than incoming cash during a specific period. Positive cash flow is the opposite, meaning that the business has more incoming than outgoing cash.
While the concept is straightforward, tracking the movement of money through a business can get complicated. If you have a small business accounting system in place, you can quickly generate a cash flow statement. Along with your small business’ balance sheet and profit and loss statement, these make up the main three financial statements for a business.
Example of Negative Cash Flow
It is common for businesses to experience periods of negative cash flow which may be expected in some cases. As the saying goes, it takes money to make money.
For example, a new business may not generate enough revenue to sustain itself at the beginning. Hence, many entrepreneurs may need funding to start and expand their companies. Some tech startups, in particular, can go for years without making a profit.
However, it is not practical for small businesses to operate without making a profit for years. But initial investments may yield returns, and the business can become profitable eventually.
Seasonal businesses also face predictable periods of negative cash flow. For instance, a popular beach town restaurant may generate most of its revenue during the summer months. Once the busy season ends, the restaurant may experience lower labor and supply costs. Nevertheless, it may still require a business loan or savings to cover the remaining operating expenses during the offseason.
How does negative cash flow affect a small business?
Negative cash flow can pose a significant challenge to a business in the short term. The pressure to reduce costs can intensify if you’re witnessing a gradual decline in your business bank account, and this can lead to negative long-term consequences for your finances.
For instance, you may not be able to invest in quality equipment, which may result in spending more money on repairs or replacements further down the line. Alternatively, you may decide to delay hiring additional staff or launching a marketing campaign, which can perpetuate the issue if you subsequently encounter staffing shortages or struggle to boost sales.
If the business continues to lose money, you may have to lay off employees, forego your own salary, fall behind on payments to vendors and creditors — or even shut down the business entirely.
Is it OK to have negative cash flow?
Operating with negative cash flow isn’t necessarily a bad thing. Even giant, international and world-famous corporations operate at a loss for some months or years. Sometimes, they even lose money and experience negative cash flow on purpose to invest in something that will produce massive profits in the future.
There are several scenarios that can cause a company to experience negative cash flow, even though the company isn’t necessarily in a bad place. For instance, purchasing a large business, spending money to open a new branch, creating a new product line or service, launching a marketing campaign, or ramping up for a busy season. In these cases, the companies are following a plan that requires an initial investment. If they’re measuring their cash flow over a given month or quarter, they might record negative cash flow for that period. However, it’s a strategic decision to invest in the business.
In contrast, negative cash flow can become an issue when you don’t have a plan or strategy. If you unexpectedly find yourself in the red due to declining sales, unpaid invoices, or increased expenses, you’ll need to figure out how to improve cash flow.
How long can you operate with negative cash flow?
You can operate with negative cash flow so long as you have cash reserves or access to small business funding to continue operations.
As a startup, it is common to operate at a loss initially and keep track of your cashflow runway, which is how long you can last with negative cash flow until you run out of money. To find your cashflow runway, you can calculate your burn rate, which is how quickly you’re losing money. To do this, figure out how much cash you have on hand, calculate how much money you’re losing each month, and then divide your cash by your burn rate. For instance, if you have $60,000 in reserves and you’re burning $5,000 a month, your runway is about 12 months.
However, your burn rate and runway aren’t set in stone. If you’re worried about running out of money, you may be able to extend your runway or switch things around and have positive cash flow by increasing your income or lowering your expenses.
To improve your cash flow, you need to focus on the three things that affect it: money coming in, money going out, and the timing of these transactions. Here are some steps you can take to improve your cash flow:
- Raise prices: Although it may seem counter-intuitive when you’re worried about losing customers, increasing your prices may be necessary to stay in business.
- Look for ways to increase sales: Consider how you might spur new business. You can try a new product or service, promotions, discounts, or marketing campaigns.
- Cut operating expenses: See if you can decrease your monthly costs by making your business more efficient. You can shop for new business insurance plans, negotiate discounts with suppliers, and cut energy costs.
- Ask vendors about terms: While it won’t save you money overall, a terms account lets you pay for invoices over time. Having more time can help you align your income and expenses to smooth your cash flow.
- Don’t delay sending invoices: Review your invoicing methods to minimize collection delays. When customers pay on terms, you can offer a small discount to incentivize them to send you the payment sooner.
If you need to improve your cash position, you can consider funding for your business, including an unsecured loan or line of credit. While you’ll need to repay the loan over time, financing can give you the funds you need to weather a slowdown or implement a strategy that will increase sales and improve profits.