When starting out in business cash flow is one of the most important issues that a business owner will face. On average 25% of all new businesses will have failed by the end of year one and 55% by the end of year five. As small business accountants we have seen lots of businesses go under as a result of bad cash flow so we thought we would outline some of the potential pitfalls and offer some advice to combat them.
Customer and supplier terms out of sync
This can occur when a business sets its payment terms to customers for a period which is greater than the terms offered by its suppliers. For example if a business’s customers have been set terms of 60 days but suppliers have terms of 30 days then this will lead to cash flow issues that will get worse with time.
The business could re-negotiate the terms with its customers and/or suppliers. If this is not possible with some existing customers (possible because there is a contract in place) then an early settlement discount could be offered. This is a percentage discount offered on the sales invoice for early payment by the customer.
Factoring could also be used here as a short term solution. This is where an institution will lend your business short term cash based on the amounts you have invoiced. This should really only be used for a temporary fix in this instance as it would only delay the underline issue.
This can lead to businesses not fully understanding how much is owed to them and by which customers, and the amounts owed out to suppliers. This may lead to lower amounts of cash being received from customers and unexpected amounts of money becoming due to suppliers.
It is important to keep good and accurate records to avoid this from happening. Bookkeeping software such as Kashoo can be used which will help keep a business’s records in good order and produce reports such as aged debtors and creditors showing how much is owed in and out and for what time periods.
Customers paying late or not at all
If a business does not have credit control procedures then this could lead to customers not paying on time or even not at all, resulting in bad cash flow and bad debts.
There are a number of ways this problem could be solved. The first is to set up good credit control systems and processes. This could be something along the lines of reminder letters sent at certain intervals after the overdue date, followed by passing the account to a debt recovery firm if it exceeds a certain time limit (such as 90 days).
Another process that can be done to prevent this from happening could be to complete a credit check on customers before offering credit terms. This will greatly reduce the businesses risk and lower the bad debit suffered.
Asking for a deposit or issuing pro-rata invoices to customers will also greatly reduce the amount of bad debt within a business. Although sometimes this may put potential customers off if they have not had previous dealings with the business.
Low profits/losses will eventually cause bad cash flow.
This can happen quickly or over time depending on the business’s financial position and the size of the loss the business is making.
In this situation, the reason behind the low profits or losses should be explored and a solution should be implemented as soon as possible. It may be that prices need to be increased or it could be that expenditure needs to be better controlled, whatever it might be it is key that this is addressed as quickly as possible.
Prepare a cash flow forecast
This is probably the most important projection a business can make. By inputting the anticipated incomings and outgoings in a spreadsheet, problem areas can easily be spotted and a great deal of information can be extracted. Information such as when positive cash flow can be expected and how much of a surplus/deficit is anticipated on a month by month basis.
As each month passes the actual figures can be included on the cash flow forecast. This will enable comparisons of the projected figures against the actual figures and any variations can be explored. These variations can then be used to adjust the cash flow forecast prospectively.
This is important information for all business owners as it can form the basis of decisions being made regarding anything decision on sales tactics to amount of capital a business will need to raise.
Some businesses may grow very fast and therefore may require more cash than they have in the bank. It could be that a business selling products may receive lots of orders from customers but not have the available funds to manufacture or order products to fulfil these orders.
Here the business will require access to short term cash so that the orders can be accepted. A line of credit such as an overdraft from the bank would be a good option for this situation as interest would only be payable for the amount of time the money was borrowed for.
All new businesses could be presented with one or more of these challenges during the early days so it always pays to keep on top of cash flow and try to keep reserves and contingencies just in case.
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We work very closely with our expert accountants to bring you the latest factually correct tax and accounting news. We also enjoy writing about small business news that we hope you find useful!