Cash flow problems can cause otherwise successful businesses to go bust. This is a truth that bears repeating, which is why this about the third article in which I have repeated it!
Small businesses are especially at risk as they may not have reliable access to sources of finance, having to turn to loans to get them out of trouble, which will, in turn, negatively affect their future cash flow. So today we’re going to be looking specifically at the theory and practice of good cash flow:
- The benefits of forecasting your future cash flow.
- Common cash flow problems a business may experience.
- Five practical steps you can take as a business owner or accountant to ensure that the deadly risk of having negative cash can be mitigated or avoided altogether.
Benefits of a cash flow forecast
Firstly – what is a cash flow forecast? Sometimes called a ‘Statement of Cash Flows’ a cash flow forecast is a prediction of how much cash the business will be receiving and paying out each month. While your profit & loss forecast tells you how much profit the business is making by recording what the business owes and is owed, a cash flow’s bottom line shows what is in the business’ bank account at the end of each month.
Sometimes, this can be dangerously close to ‘not enough’. If the business ends up not having enough money in the bank to meet its responsibilities at the end of the month, then bad things will happen. But how could this happen? Well, easily, if you get paid too late, or if the business has to shoulder unexpected costs.
This can happen even if the business is profitable. How? Well, profit just displays the net result of the business’ agreed transactions in a period compared to the losses it makes. Depending on the business this could be very different to its cash position. Relying on profit alone to determine whether a business will be sustainable doesn’t deliver enough information. You need to have a forecast of the cash the business will actually have in its pocket to pay its bills at any given time.
If the business ever fails to have cash available to pay its suppliers, its employees and the government, then it will need to quickly liquidate some of its assets, or get into debt in order to survive. The alternative is bankruptcy.
Cash flow problems a business might experience
What could cause a business to have cash flow problems? Here are three common examples:
1. Business Model – Profit Margins
Measuring business success on profit margin alone can be a dangerous road to follow. Profit margin is the amount by which sales revenue exceeds the costs of the business for a given period. This period could be a month, a quarter, or a year. These long timeframes help to further disguise the actual movements of cash in the business. As we’ve already discussed, the business may have a healthy profit margin, but the promise of profit cannot be used to pay bills.
2. Stock Management and Seasonal Trends
If your business is seasonal you will sell more at certain points of the year. Great, right?
Well – it is – however with increased income also come increased costs. Whether you resell products, construct them yourself out of raw materials, or have other costs that directly relate to the sales you make, these will increase along with your increased sales. This can lead to unexpectedly high bills. If you get paid in the time you expect to be paid – all well and good. But a few late payments or higher bills than anticipated could leave you with a cash shortfall.
In addition, if the business maintains a stock of inventory it will be purchasing new stock before it is sold. This increases the risk that the business will have stock lying dormant and unsold for an extended period of time, especially if bulk stock purchases are made in advance to anticipate seasonal trends. Paying for something before it delivers revenue will always carry a risk, but the greater the potential lag time between stock purchase, sale and payment the greater the risk.
3. Creditor and Debtor
It’s easy to assume that you will be paid by a certain date. However there may be few practical ways you can enforce this to the letter. There will always be late payments in business. But the consequences for your business could be far worse than for those responsible for the late payment.
Managing creditors and debtors can be a fine balancing act – one in which you may find yourself being the dreaded late-payer in order to cover working capital gaps that emerge in your business for the very same reason.
5 tips to manage cash flow better
1. Get your accounting, invoicing and cash flow forecasting sorted
Foreseeing problems before they happen to you is the foundation of business planning.
It’s important to invest some time and energy at the start of a business to make sure you have good systems (and good people!) for dealing with the financial activities of the business. These include, but are not limited to:
- Managing regular expenditure
- Purchase orders
- Payroll (not just salaries, but pension arrangements and NI – national insurance tax)
- Tax (VAT and Income / Corporation Tax, if applicable)
- Keeping track of all of the above!
If you feel like you are not in full control of your businesses’ finances the first step is to build a picture of what is actually happening financially in your business. What are the transactions the business makes and what are its obligations? Only once you know this can you answer the question that might be praying on your mind more – can the business fulfill its obligations and its aspirations.
Collating and presenting this information is often made easier by using online accounting software. Most are services that businesses, or their accountants, can use to produce useful outputs to keep track of the businesses’ finances. At minimum, a monthly cash flow graph will help you keep on top the of the businesses cash position and identify how close to the line the business is running in terms of ready cash. There are many more tools you can use to analyse the businesses’ cash health. Simple calculations like days sales outstanding (the average time it takes for revenue to be collected from a sale) will help you identify inefficient practices and also provide information to help you plan effectively for the future.
2. Bill upfront
The best way to avoid a feast and famine situation is to bill up front. This may not be the way you are thinking of doing business, but it is worth seriously considering the advantages and disadvantages of this before you make your decision. Billing upfront means there is cash in the businesses’ pocket before the business itself needs to make a commitment, be that a product or service.
Needless to say, this is a big advantage if the flow of funds could be an issue for the business. If you bill upfront delayed payments only mean delayed delivery of a product or service. This may carry its own problems but at least the business has not already spent cash.
3. Invoice payment terms
Invoice payment terms are another way you can control the period in which you wish to be paid. By reducing the agreed days to payment you can ensure that the gap between making a sale and receiving cash is reduced. Having payments received quickly will help the business move towards a positive cash flow, and reduce the risk of delayed payments.
4. Provide easier ways to pay
Your customers are going to be happier about completing a transaction and making a payment if it is simple and convenient. Find out how your customers would prefer to pay, and provide those payment mechanisms. Whether this means investing in physical equipment or in more online payment methods, it can be worth it in the long run.
5. Employ a bookkeeper / accountant
Managing the inflow and outflow of cash from the business is a fine art – and something many businesses employ an accountant for. Beyond handling the basics of managing invoices and bills, you could also hire a professional to chase invoices (further reducing the chance of late payments) or provide good quality information on the financial state of the business.
Don’t let your cash flow kill your small business. Sign up for Brixx today and get a handle on your cash flow!
If you haven’t already, take a look at our online app, Brixx. We specialise in financial planning, helping you identify the feasibility of your business ideas and giving you the tools to make financial models of any business, complete with dashboards and financial reports. By plotting the future of your cash flow you can foresee and find new approaches to problems before they happen.