Effective cash flow management is vital to ensure that your business has the funding needed to keep trading and make the most of opportunities to grow. A business can survive for a short time without sales or profits, but not without cash.
You need to keep a careful eye on your cash position at all times. That means systems that let you predict your cash flow with confidence, keep tight control and deal with any potential shortfalls before they become problematic.
Cash flow is the balance of money which flows in and out of your business
Cash flow is the actual payments of money, as opposed to what is owed to you by your debtors or by you to your creditors.
The cash flow generation of your business may be limited by what industry you are in. But to a large extent it depends on how well you run your business.
The main inflow of cash is usually the cash from sales
If you sell on credit, your cash inflow is delayed until you are actually paid. Effective credit control is essential.
A business which purchases on credit and is paid in cash, such as a retailer, is at a great advantage in cash flow terms.
New finance provides a one-off boost to your cash flow
In the past, most businesses have relied on bank overdraft finance and have reached their borrowing limits quickly. Different funding options allow you to raise more finance.
Expenditure includes paying for your overheads
Salaries (including tax and National Insurance) are often the largest and most inflexible cost.
Other major costs might include stock, raw materials and any capital expenditure.
Many businesses have to fund large amounts of work-in-progress. For example, you might spend several months working on a project (and paying for materials and labour) before you can invoice a customer and get paid.
VAT and other taxes tend to be paid out in large lumps
You can be penalised heavily for late payment.
Buying significant items just before a VAT period ends, rather than at the start of the next one, can help your cash flow.
Your business needs to give its owners and financiers a return on their investment
You must pay interest - and repay capital - to lenders such as the bank.
If there is spare cash, you and other shareholders may want to draw back any personal loans made to the business or take dividends.
Monitor your actual performance against budget and cash flow forecast regularly
Do this at least once a month, and preferably once a week. By comparing your performance with the budget, you can quickly judge whether sales and profits are going to plan.
Identify any problems and take immediate action. For example, if you know you will be short of cash in three months’ time, you might reduce stocks, slow down sales growth, or agree extended credit from a major supplier for that period.
The only way to generate cash over the long term is through retained profits.
Check you will have enough cash before taking on large financial commitments
This includes major new orders.
Create a useful yardstick by working out how much extra working capital is required to fund each 10% increase in sales.
Restrict the growth of your business to levels you can comfortably afford to finance. Always keep a financial reserve available for contingencies.
Develop systems that warn you of problems
You need to know as early as possible if leads, orders or sales fall below a certain threshold, if planned sales will be later than forecast, or if a substantial customer stops buying from you.
You also need to know when key indicators, such as profit margins, liquidity ratios and stock ratios, deteriorate beyond an agreed limit.
You want to monitor any substantial invoices which are in dispute, late debts and customers exceeding their credit limits.
Build productive relationships with your key suppliers
They will be more likely to extend extra credit to you when you need it.
If you expect problems paying a tax bill, contact the HM Revenue & Customs (HMRC) Business Payment Support Service (0300 200 3835, Mon–Fri 8am to 8pm, Sat and Sun 8am–4pm).
No profits and no cash flow
Bad business practices that cause many needless business failures include:
taking on financial commitments before the business can afford to pay for them;
doing large amounts of speculative work in the hope that a customer might then purchase what you have produced;
overvaluing stock, work-in-progress and fixed assets such as machinery;
making no provision for major expenses which you know are likely to happen;
failing to do any cash flow forecasting, particularly if your business is struggling to grow;
failing to agree the details of an order with the customer, or the payment terms, which leads to a dispute;
failing to implement an effective credit control system, starting with credit checking prospective customers.